Open-ended property funds were back in the news last week after it emerged that outflows had picked up in July. To me, the remarkable thing is not that the growing threat of a no-deal Brexit has sparked a fresh round of redemptions, it is that more than three years on from the EU referendum, open-ended funds remain as popular as they are.
Despite all the bad press and fund suspensions in 2016, daily traded property funds remain the default option for wealth managers. Indeed, some funds are now significantly larger than they were before the run on the funds three years ago.
As we report this week, the reason open-ended funds continue to prosper is a tale of inertia. The Financial Conduct Authority (FCA) has moved in a glacial fashion. After publishing long-awaited proposals for reform last October, it has still to reveal its final position.
Furthermore, the proposals themselves, which call for greater transparency and disclosure from funds, do little to address the fundamental issue: daily trading is highly problematic for property funds because it takes months to sell a property.
The danger is that if investors suddenly panic and demand their money back, fund managers can’t sell property fast enough to raise cash and have to suspend trading.
When the market outlook is uncertain, funds have little choice but to ramp up their cash levels, which acts as a drag on returns. With their cash levels currently close to 19%, they look to be preparing for the possibility of a no-deal Brexit at the end of October. If there is a no-deal, I’d be surprised if even these cash buffers prove sufficient to avoid the need for fund suspensions.
Any meaningful reform would do away with daily trading. The big obstacle is the structure of the wealth management industry. Financial advisers increasingly follow model portfolios provided by discretionary fund managers and these currently require daily liquidity. Changing this would require a major overhaul, something the wealth management industry is unlikely to contemplate for the sake of a few property funds.
But there is some hope in the form of embattled fund manager Neil Woodford. The suspension of his flagship Woodford Equity Income Fund has highlighted how the issue of liquidity mismatch in open-ended funds is not just a property problem. Woodford’s fund ran into trouble because of its investments in unlisted companies. The issue has caught the attention of Bank of England governor Mark Carney, who said recently that open-ended funds were “built on a lie, which is that you can have daily liquidity for assets that fundamentally aren’t liquid”.
Last month, the Bank of England said it would team up with the FCA to review redemptions terms offered by open-ended funds. Yes, I know, yet another review. But maybe now that there is an appreciation of the potential scale of the liquidity problem in open-ended funds, it will spur the regulator to push for lasting reform.