For almost five years now, investors in open-ended property funds have experienced a rough ride.
Problems first surfaced in summer 2016 with property fund managers forced to suspend trading in response to floods of redemption requests after the UK’s vote to leave the EU. Despite most funds reopening their doors over the following year, just last year property funds were once again forced to pull down the shutters due to the economic turmoil caused by the pandemic.
As recently as October 2020, more than £5bn remained trapped in open-ended property funds. Even with the end of pandemic in sight the theme continues to play out. In May, Aviva closed the doors on its open-ended Property and Feeder funds.
The mismatch between the illiquid nature of property funds and the offer of daily dealing is clearly something that needs to be addressed. And in May we saw the first signs of notable progress.
The Financial Conduct Authority (FCA) launched a consultation, CP20/15, in August 2020, and in May published a Feedback Statement. The key proposal is to introduce notice periods of between 90 and 180 days before assets can be redeemed.
As the regulator notes: “The potential for harm arises because the offer of frequent (typically daily) dealing in units of some property funds is not aligned with the time that it takes to sell the underlying assets in which the funds invest.”
Firstly, we’re pleased to see the FCA grasping the nettle here. While property will always be less liquid than other risk assets such as equities, investors need more protection here. Fund suspensions should be rare and reserved for extreme circumstances. But unfortunately, open-ended property fund suspensions have become the norm. Being locked out for months or even years should not go with the territory.
However, while a notice period makes sense, there are some obstacles; platforms and advisers may find it difficult, and perhaps even impossible to implement, not least due to the widespread use of model portfolios which rebalance on a regular basis.
That said, much will hinge on the final rules. And the good news is, we’re unlikely to be forced into a knee-jerk reaction. A planned implementation period of between 18 months and two years provides time for platforms to consider whether adding notice periods is practical. The FCA has also said a final decision will not be reached until Q3 2021 at the very earliest.
Even if the regulator pushes through with the proposal, Praemium is in a stronger position to navigate the operational challenges than most by virtue of owning our own tech. But the most important consideration for us here is the potential effect on you and your clients. We regularly seek your feedback to improve the service we provide for you and so true to form during any implementation period we will work closely with you to ensure any solution is built with your needs in mind.
The FCA, in its defence, isn’t overlooking the problems for platforms. It conceded that the relatively small number of funds and client assets offers platforms little incentive to make the required upgrades. Roughly three-quarters of property funds are distributed via investment platforms, but the UK property sector accounts for less than 1 per cent of funds under management in the UK.
But this must be balanced against the importance of property as an asset class. The sector’s recent woes aside, many investors have enjoyed good returns from property funds and trusts over the past couple of decades or so – not to mention the pivotal role they play in diversifying investment portfolios.
The FCA’s final reforms will also be influenced by further consultations and developments where significant crossover can be found. In May, the FCA launched a consultation proposing a category of an open-ended fund called the long-term asset fund (LTAF), designed to enable clients to invest more efficiently in long-term, illiquid assets. It aims to lift some of the barriers faced when investing in infrastructure, private equity, venture capital, and property.
The FCA referenced the LTAF consultation within its open-ended property one: “Given the crossover between the LTAF proposal, and the possible introduction of notice periods for property funds, we will also take account of feedback to our LTAF consultation paper and wider progress on the LTAF before finalising our policy on notice periods for property funds.”
Platforms and advisers must also be aware of the potential impact on product wrappers. In October last year, HMRC launched a consultation proposing a 180-day notice period for open-ended property fund investments in individual savings accounts (ISA). Under current ISA legislation, which enables account holders to access the funds or transfer them to another ISA within 30 days of making an instruction to their account manager, such funds would no longer qualify as eligible investments. Also, in the past few years, self-invested personal pension providers and platforms have been treating open-ended property funds as non-standard assets in response to the mass suspensions While initially believed to be a temporary measure, it’s looking increasingly likely this will become permanent.
So, we can see there’s still some uncertainty about what shape the final reforms will take. Of course, we’ll be eagerly awaiting further guidance from the regulator, while keeping fingers crossed that any proposed remedies not only help steer open-ended property fund investors through calmer waters but can also be easily implemented and adopted by platforms and advisers alike.
1 FCA feedback statement to property consultation - https://www.fca.org.uk/publication/feedback/fs21-8.pdf - May 2021
2 Investment Association March 2021 stats - https://www.theia.org/sites/default/files/fund-statistics/stats-0321-12.pdf