THE Financial Conduct Authority (FCA) has at last published a discussion paper around property funds and is looking for input between now and November before making decisions.
Property, as in good old bricks and mortar, has been seen as a safe investment, but problems have occurred for many reasons over the last five years. Moreover, it is seen as a perfect negative correlation to stocks and shares (equities).
Negative correlation is balancing risk by buying an ice cream company and a Wellington boot company. In normal conditions both do fine, but in severe conditions (sustained warm weather), the Wellington boot company is kept afloat by the ice cream sales in a portfolio.
Whether or not you know it, most people hold property as a diversifier in their pensions/ISAs et al.
Depending on how you measure risk, property can be seen as low risk.
If we measure risk by how much a return deviates away from its normal return (say standard deviation), a property fund is generally low risk.
There are however, inherent risks that can make the fund fall, as investors in the ultra low risk zero dividend preference shares found out. While an extreme example, overnight investors in such funds turned a £100,000 investment into pennies – not bad for a ‘low risk’ fund as measured by just that one measure – standard deviation.
Clue – measure it by varying methods of risk analysis.
Property funds came under pressure in the financial crisis and then again, in the run up to a Brexit vote where investors believed property would take a hiding.
The same happened in the Lehman’s collapse where investors tried to sell out of property quickly, driving the prices down further – the negative feedback loop I often refer to.
Property investment funds
The real problems occurred where an investor tries to encash property in a certain type of fund called an OEIC (Open Ended Investment Company). Such funds have a completely inappropriate liquidity mismatch. To explain: The underlying value of the assets held in the funds are not fully known until they are sold, but investors value, sell and buy on a daily basis the units (like a share) in a fund.
When the market falls like this, the funds that hold such property do not have the cash to repay the redemptions and so have to ‘gate’ the fund, i.e. block redemptions so investors have to wait.
Knowing this, and knowing investors are selling, buyers sit back and light a fat cigar with a brandy, watching the prices fall further and further and then move in. The fund ‘has to’ sell as the investor wants the money. Such a process is a stupid liquidity mismatch and causes a self-fulfilling prophecy.
To circumvent this, the FCA has proposed a 180-day notice period of encashment for investors. This has been marked as the ‘end’ for retail investments in property portfolios.
Personally, I think that is a pile of twaddle.
The main reason investors are there is to diversify. In any financial planning, there is rarely a time where an investor needs all their money within six months. Most hold just 10 per cent of their money in property. An investor would simply liquidate whatever they need and await the remaining capital to arrive.
This smooths the underlying price and cuts out a large part of ‘hot money’ flying in and out destabilising prices.
Other scaremongering of the ‘end is nigh’ shows that the longer redemption policy would make property funds inadmissible in an ISA and SIPP (self invested personal pension).
The FCA and the revenue are considering this. This is an unintended consequence and could easily be protected against by a change in the regulations for ISAs and SIPPs. It’s no biggy but made a nice headline
If fund managers also do not have to hold up to 25 per cent in cash or quoted property investment trusts, this frees further liquidity back into the market.
In short, the headlines were, well, just headlines.
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