Triggered by the belated realization of the risks in mutual funds that offer daily liquidity but invest in illiquid assets.
Over the past two days, 10 open-end property funds in the UK have slammed their doors shut on investors, citing concerns about asset valuation. The funds’ two property valuers, CBRE and Knight Frank, say that it is currently impossible to accurately value the funds’ real estate assets amid the market chaos being caused by the response to Covid-19.
“The UK commercial property market is facing unprecedented circumstances as a result of the COVID-19 outbreak, and so valuation firms can no longer make reliable judgement on value. This is known as ‘material value uncertainty’,” said Paul Richards, managing director of the Association of Real Estate Funds (AREF), in a statement. To justify the fund suspensions, Richards cited new FCA rules applying to funds investing in inherently illiquid assets, such as commercial property:
“Funds with more than 20% of their portfolio subject to material valuation uncertainty are required to suspend subscriptions and redemptions in the interests of all investors. Although these rules are not due to come into force until September 2020, existing rules would require fund managers to consider suspending funds in circumstances like the ones they are facing at the current time.”
The first fund to shut its doors was Kames Property Income, with £504 million under management. That was on Tuesday. By Wednesday morning, Janus Henderson and Aviva, which respectively manage property portfolios worth £2 billion and £461 million, had followed suit. Then, over the next 24 hours, another seven funds did the same.
Between them, these funds manage some £11 billion of assets, equivalent to around a third of the total assets under management in the UK’s property fund sector. They invest in commercial real estate across the UK including offices, industrial property and retail parks, a sector beleaguered by retailer failures and crushed values. Just this week, one of the UK’s largest mall owners, Intu, warned that it was on the verge of bankruptcy after posting a £2 billion loss and a 22% plunge in the net asset value of its commercial properties.
Now, it’s the property fund sector that’s beginning to wobble. That includes the sector’s biggest player, the £2.9 billion Legal & General UK Property, which, like AREF, justified its decision to suspend redemptions by citing the “unprecedented set of circumstances caused by the COVID-19 virus” and its impact on “market activity across all sectors”:
“This means that “independent valuers are unable to rely on previous market experience to inform their opinion of values of the properties held by the Fund. We believe this suspension to be the fairest outcome for all investors, taking an appropriate forward looking view through the current crisis.”
Other large funds that have suspended redemptions include the £2 billion Janus Henderson UK Property, the £1.7 billion Standard Life Investments UK Real Estate, the £1.1 billion Threadneedle UK Property and the £1.1 Aberdeen UK Property. These open-end mutual funds are particularly prone to liquidity crises in the event of market sell-offs, as the Bank of England’s Financial Policy Committee warned repeatedly, starting in 2015.
When investors take their money out, the fund will use up the remaining cash and then has to sell assets in the portfolio to raise money to meet the redemptions. This is normally not a problem when the assets in question are highly liquid, such as large-cap publicly traded stocks. But when the assets are commercial real estate that can take weeks or months to sell, if they can be sold at all in a hurry, particularly in a downturn, there is a mismatch in liquidity between what the fund offers to its investors (daily liquidity) and what the fund holds (largely illiquid assets). Eventually, the fund runs out of cash and has no choice but to close its doors, leaving investors trapped and having to contemplate big losses.
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Nick Corbishley 