In the investment world, commercial real estate funds were the biggest victims of the Brexit vote.
After the EU referendum on 23 June last year, a sense of panic began to stir among investors, who decided to cash in their investments over fears that British assets would fall in value.
But it was UK commercial property funds that really felt the brunt of the pain, and in the days that followed the vote, this stampede forced several investment vehicles to suspend trading.
For weeks, these billion pound property funds were frozen with investors’ money locked in, and it wasn’t until December that all seven investment vehicles reopened for trading again.
How do these funds look now?
It’s been just over a year since the funds gated, and according to Darius McDermott, managing director of Chelsea Financial Services, 43 of the 48 open-ended funds in the Investment Association (IA) property sector are now back in positive territory.
Returns for 2017 so far have been ahead of expectations, although they’re not particularly exciting, says Nathan Sweeney, senior investment manager at Architas.
He says many property managers were surprised at how well the market held up after the Brexit vote. “If you look back to the weeks after June 2016, there was a lot of money leaving the sector over fears of a significant write down in UK commercial property values, and that has not happened.”
In fact, the weaker pound has actually encouraged more overseas institutional money into the space as foreign investors look for opportunities.
While the pressure in the commercial property market has eased since this time last year, there are still concerns over how Brexit will unfold and what effect this will have on the UK economy, says Laith Khalaf, senior analyst at Hargreaves Lansdown.
He points out that commercial property funds still carry the same risks they did on the eve of the EU referendum, meaning the funds are not immune from another big freeze if a major event transpires which prompts a surge in outflows.
However, the Financial Conduct Authority (FCA) is looking to address last year’s issues through reforms which aim to prevent a repeat of last year’s gating saga. Yet there are now concerns that imposing more red tape could have unintended consequences on the markets.
Many commercial property funds are holding hefty amounts of cash to provide liquidity in case large numbers of investors try to recoup their cash again. On average, funds are currently holding between 20-25 per cent in cash. This cash buffer means there is more liquidity to meet outflows if there is the risk of another panic sell, which reduces the likelihood of another gate.
But it also means there’s a large slug of investors’ money that isn’t doing anything, which can weigh down on the performance of the fund.
According to Sweeney, fund managers have become more defensive over the year, focusing on assets that should be easier to sell if necessary. They are also tending to tap into property that provides income, rather than adding value through capital appreciation.
These funds have a suspension mechanism in place to prevent a firesale of assets, which ultimately protects the remaining investments from plummeting in value. This is particularly important bearing in mind it can take months to sell property.
While some market players were very critical of last year’s gating drama, professional investors tend to agree that having this mechanism in place is a good thing. McDermott says it stopped investors from panic selling and crystalising some significant short term losses.
“Yes, it was frustrating for anyone who needed to access the money at the time, but there shouldn’t have been too many people in this position. Investors who are in these types of fund should be long term investors with cash holdings for emergencies.”
There’s no doubt that confidence in the asset class has improved over the year, with figures from the IA pointing to positive net sales between March and May this year, following five consecutive months of outflows.
Should you steer clear?
McDermott says investors shouldn’t be put off by the gating experience. “While I’m not overly keen on the asset class at the moment, due to lower yields and an uncertain outlook in the short term, I do still think it has a place in a wider portfolio for both diversification and income.”
When there’s a rush of money leaving property funds, investors should sit back and take the income, or accept a lower valuation if you can’t wait, says Sweeney.
“If you are concerned about the outlook for the core commercial sector then you could consider specialist property that can provide an alternative route into the asset class.” These include property types such as industrial warehouses, student accommodation, and hospitals, which all offer different structural drivers of return with a reasonable income.
But for an illiquid asset like property, closed-ended investment trusts could be preferable for investors because they don’t have to trade on a daily basis – and therefore don’t need large amounts of liquidity. Due to their structure, property trusts have no need to gate, but can see discounts widen considerably, meaning you could lose a large chunk of your investment if you sell out.
So while property funds remain a good option if you’re looking for an alternative to equities and bonds, you should tone down your return expectations. The continued uncertainty in the UK means these funds are unlikely to cut their large cash weightings anytime soon.