London’s financial markets today continued to struggle in the wake of news, which broke yesterday, that Standard Life Investments has suspended trading in its £2.9bn UK Real Estate fund, in response to a surge in redemption requests following last month’s UK vote to leave the EU.
Shares in a number of listed UK commercial property companies were down at midday Tuesday, after having also fallen on Monday afternoon on the news. The FTSE 100 was up slightly in London at midday, after falling initially. It rebounded after the Bank of England announced measures to free up money available for lending by reducing the UK’s counter-cyclical capital buffer rate, to 0% from 0.5%, market commentators said.
In a statement, Standard Life said the decision to close the fund would be reviewed every 28 days.
By early afternoon on Tuesday, news that a second major property fund – Aviva’s £1.8bn UK Property Trust – had been closed to redemptions since Monday afternoon sent further tremors through the market, and saw share prices in other businesses exposed to commercial property fall further.
The suspension in trading of the Standard Life fund, which invests in prime UK commercial real estate assets, was seen by some observers as a sign that warnings the Brexit vote could lead to a downturn similar to that which occurred in 2008 might be about to come true; the news of the Aviva fund closure seemed to confirm it.
In 2008, the rapid fall in commercial property prices resulting from forced sales was seen as a key factor in fueling the 2008 financial crisis.
Funds industry experts, though, stressed that open-ended property funds of the Standard Life type are by their nature illiquid, and thus sometimes need to be “gated” to protect investors, who, by investing in such funds, will have chosen a long-term view.
‘Real sign of the outflows’
One such expert, Patrick Connolly, with Bath-based advisory firm Chase de Vere, echoed other commentators in observing that Standard Life’s decision to stop trading on its property fund was a “real sign of the outflows which funds are experiencing” at the moment, in the wake of the Brexit vote, and that other managers were “likely” to follow suit, “even if only as a precautionary measure” in response to their own similar levels of outflows.
But difficult though it may be, he added, investors “need to be brave” in the face of such developments, even though “property funds have already marked down prices, and as there are currently more sellers than buyers, it is possible that prices will fall further”.
“Commercial property is an illiquid asset class, and so investors need to adopt a long-term approach and not look to make short-term tactical trade,” he said.
“While Standard Life’s decision will be disappointing to those wanting to access their money, it is understandable, and has been made for the right reason; to protect existing investors.
“Investors should not panic, and instead should sit tight, understand that there will be periods of good and poor performance with any long-term asset class, and ride out this period of negative sentiment.”
Tilney Bestinvest managing director Jason Hollands pointed out that Standard Life took the decision to close the fund just days after it, like a number of other commercial property fund managers, had applied “market value adjusters” to reduce the value of their holdings ahead of formal independent valuations.
In the case of Standard Life, this amounted to a 5% reduction in the value of the portfolio, which, Hollands noted, was at the upper end of discounts being applied.
The reduction may have been a “prudent, pre-emptive approach to the valuation of assets”, but it nevertheless appears to have been enough to “spook certain investors into seeking to withdraw funds”, Hollands added.
“The coming days will reveal whether this becomes a wider phenomenon across the open-ended property funds sector or a specific issue for Standard Life, due to some large holders seeking to redeem their investments.
“Reaching 10 to 15% liquidity buffers will be the potential trigger points for other funds to suspend trading.”
Like Connolly, Hollands stressed that Standard Life’s actions were “squarely aimed at protecting the interests of all shareholders in the fund when there is lack of clarity over the pricing of property assets”, rather than a cause for panic in themselves.
“Unlike listed shares or bonds, which are traded and have many holders, resulting in a fluid and transparent price setting process, physical property assets – all of which are inherently unique – are illiquid and have a slower price discovery process,” he said.
“When there are more sellers than buyers, this can prove problematic for funds owning physical assets such as offices or warehouses, as it takes time, and transaction costs, to liquidate these in order to generate cash to return to shareholders who want out, and a forced seller in uncertain market conditions is unlikely to achieve a great price.
“This is why open-ended property funds have to hold large buffers of cash and other liquid assets.
“And here the current challenge predates the outcome of the EU referendum, as property funds have seen redemptions for some months, meaning cash buffers will likely have declined ahead of the shock outcome of the referendum.”
Hollands said that while the uncertainty resulting from the Brexit referendum result “is undoubtedly a challenge for the property sector”, it was “not a post-Lehman Brothers moment, when the whole financial system faced collapse and the supply of credit – key to property transactions – was in doubt”.
“The Bank of England has set out its readiness to provide vast amounts of liquidity, and interest rates look set to be cut,” he went on.
“Talk is moving decisively in favour of a pro-growth rather than a tax-hiking Budget. The stock market has weathered Brexit bettered than many predicted, and successful corporate bond issues this week from British American Tobacco and [Jack Daniels producers] Brown Forman suggest the Sterling credit market remains open for business.”