Yesterday three property funds, managed by Aviva, M&G and Standard Life, temporarily suspended trading. This action prevents the purchase or redemption of units in their funds.
Income payments to investors however will continue to be made. Prior to this news other open-ended property funds investing in UK commercial property, including Legal & General, M&G and Henderson, had made fair value adjustments to their funds. These were made to reflect the potential for a fall in the underlying property values, which appears to have been stimulated by the decision by the UK public to vote to leave the European Union.
These actions appear to have caused something of a ‘rush for the door’ by some investors, no pun intended, fearing that London property prices in particular could fall due to a drop in overseas demand. Data from the [UK] Investment Association indicates that net sales of £360m were made in May from property funds by retail investors, perhaps indicating that investor tension had already began to build.
Some property funds had already been running high levels of cash, with Legal & General holding 19.4% and Henderson 14.3% at the end of May, while others appear to have been holding less. Aviva for example has been holding 9.3%.
Although unknown, we can only assume that redemptions have eroded cash holdings to a level which Standard Life and Aviva feel uncomfortable with. As property requires a greater period of time to sell, the fund management groups have taken this decision so that assets can be sold in a timely fashion rather than by fire sale, enabling a more competitive price to be sought. This is in the interest of both unit holders wishing to remain in the fund and those wishing to sell.
Although they have delivered exceptionally strong capital growth, we continue to see property funds as an important income source diversifier. It is important to remember that over the longer term 75% of the return from commercial property comes from rental income and rental income growth, and it is within income producing portfolios that we take our exposure.
The suspension of the trading in these funds of course causes some concern, and highlights again whether funds with illiquid assets such as physical property should be daily pricing. For now we believe that the property fund managers have been prudent in their actions, by implementing the adjustments to the value of the underlying properties and by suspending trading, in order to provide more realistic valuations and protect the unit holders. For the moment, we will continue to allocate to our favoured property funds.
Paul Milburn is an investment analyst at Lowes Financial Management