Property fund managers have begun hoarding piles of cash in preparation for sudden withdrawals by jittery investors.
The threat of Brexit, recent stamp duty reforms and market volatility in the first quarter have all been blamed for damping investor appetite for the asset class.
Fund managers at several companies — including Aberdeen, F&C, Legal and General — are holding more cash than usual as they prepare for outflows.
“We’re probably holding the highest liquidity ever,” said Gerry Ferguson, of UK property pooled funds at Aberdeen Asset Management.
Mr Ferguson said the company’s funds were taking a “cautious” approach and holding 20 per cent of assets in cash and a further 5 per cent in equities. “Property won’t be flavour of the month forever,” he said.
“Clearly there’s an increasing possibility of some sort of pricing correction, caused by a rise in interest rates or by other asset classes looking attractive.”
Mr Ferguson added that managing outflows will be the “big challenge” of property funds over the next few years.
According to Fidelity International’s real estate investment arm, open-ended property funds are on average holding 20 to 25 per cent of their portfolio as cash or other liquid investments.
“[The level of cash] has been relatively high for the last ten to 15 years but [fund managers] have been allowing it to rise over the last couple of quarters,” said Adrian Benedict, Fidelity’s real estate investment director.
The high levels of cash illustrate a difficulty faced by open-ended property funds, which typically allow investors to pull their money out immediately — even though selling a building can take months.
“Equities and bonds guys say ‘well, we just press a button to make a sale’,” said Mr Benedict. “We can’t do that. It takes longer.”
Mr Benedict said fund managers recognised the need to manage the expectations of investors against the reality of trading property.
Guy Glover, manager of F&C’s UK Property fund, said holding high cash levels was “sensible”.
Mr Glover’s fund is holding more cash than it has done on average, with a 20 per cent allocation. Mr Glover said the fund would normally aim to have 10 to 12 per cent of assets in cash.
“We’re aware of the issues with open-ended funds, having underlying buildings that are relatively illiquid and we take a strict approach to that,” he said.
“We buy smaller lot sizes of £2m-£3m which are easier to sell in a downturn and nobody is allowed to hold more than ten per cent [of the fund].
“We’re in constant contact with investor base and everyone is reviewing investments the whole time,” he added.
Holding high levels of cash in a portfolio is often avoided by managers as in a low-interest rate environment the asset class reduces the overall returns of the fund, creating a so-called “cash drag”.
But Mr Benedict said this was something investors must put up with if investing in an illiquid asset class, while also expecting daily liquidity.
“Investors can’t have their cake and eat it,” he said.
Mr Glover agreed. “I suppose seven years ago a lot of property funds had outflows and had to sell quite a lot of assets.”
“[Holding cash] is really the industry taking a sensible approach to that liquidity question, which is only to be applauded.”
Several property funds were forced to suspend redemptions during the financial crisis, as investors sought to withdraw money at a rate faster than properties within the funds could be sold.
The open-ended fund structure has been criticised by analysts, who say that the promise of daily liquidity should not be made as property cannot be sold in a day.
Hargreaves Lansdown, the online fund supermarket, has said it does not offer open-ended property funds to investors as the structure means managers are forced to buy and sell property according to the fund’s cash flow.
Mr Benedict at Fidelity agreed the open-ended structure is ill-suited to property. “In terms of marrying a [fund] structure and the asset, listed trusts would be preferable,” he said.
Claire Madden, a partner at Connection Capital, an investment management company specialising in commercial property and alternative assets, said the open-ended structure was designed to “attract capital” from retail investors.
“A lot of funds are set up to attract capital. They give the investors certain liquidity rights so that they can raise more capital from various investors.
“The open-ended structure gives [funds] the flexibility to grow because you’ve not got a finite pot of capital, but it presents problems when things go the other way,” she said.
Property funds began to suffer outflows, last month experiencing their highest level of withdrawals since 2008.
However, analysts point out that the redemptions are a relatively small portion of the assets under management currently — and investors remain interested in property.
Andrew Summers, head of fund research at Investec, said the company remained “moderately overweight” in UK property, although recognised that the asset class will not deliver the returns it has done.
“We are clearly not expecting the total return numbers in the next two years to be what we’ve had in the last few years,” said Mr Summers.
Mr Summers said he expected rental yield to grow “a couple of per cent” from a five per cent base, while active managers could add “another couple of per cent”.
“That brings us into high single digits, which is not too bad in the current environment,” he said.
Reference: http://www.ft.com/cms/s/0/52be9858-0c5a-11e6-b0f1-61f222853ff3.html#axzz47D15RWH8