The UK's open-ended property markets sector has been hit by a number of problems, with firms closing exits temporarily due to sudden market turns. This has prompted calls for radical reform.

The UK’s main financial regulator proposes to require investors to give 180 days’ notice of pulling money out of an open-ended property fund, a measure designed to stop the problem of these funds being hit by mass pull-outs amid volatile markets. 

The Financial Conduct Authority has been looking at the problem of how real estate funds – holding illiquid property assets – have gone into temporary lockup in recent months because investors want to withdraw funds. This liquidity/asset mismatch has prompted criticism that such funds should not be open-ended, or indeed marketed to mass-market investors.

In March this year asset managers Janus Henderson and Kames Capital suspended dealings in their UK property funds, citing coronavirus-induced turmoil as a reason. This added to a difficult period for a sector buffeted by Brexit and political uncertainties last year. Janus Henderson temporarily halted dealings in its Janus Henderson UK Property PAIF and Janus Henderson UK Property PAIF Feeder Fund with effect from 16 March. Kames shut its Kames Property Income Fund and Kames Property Income Feeder funds to dealings. Last year, the open-ended funds sector was also slammed when fallen star manager Neil Woodford halted withdrawals; M&G suspended its £2.5 billion property portfolio fund in December 2019.

“Property fund suspensions have occurred with increasing frequency in recent years, including following Brexit and in the current coronavirus pandemic,” the FCA said in a statement yesterday. 

“Fund suspensions exist to protect investors in exceptional circumstances. However, the FCA has seen repeated suspensions of these funds over recent years for liquidity reasons, which suggests that there may be wider problems. The FCA is concerned that the current structure could disadvantage some investors because it incentivises investors to be the first to exit at times of stress. This can potentially harm those who remain if the fund suspends or assets are sold rapidly due to liquidity demands,” it continued. 

Reactions
A number of organisations welcomed the move, although with some reservations. 

“We have long called for the FCA to take action on the liquidity mismatch inherent in open-ended UK property funds, so we welcome the spirit of today’s consultation and its proposals. Although overdue, the consultation and the measures outlined should, on the whole, increase investor protection and mend some of the reputational damage caused by the wave of lockups we have seen over many years,” Marc Haynes, head of institutional business, EMEA, at Cohen & Steers, an international real estate firm, said.

“Today’s announcement has also undoubtedly paved the way for the REIT funds market in the UK, as we believe that investors who prefer the flexibility of a liquid vehicle are better served by property securities funds which invest in publicly listed real estate companies and REITs that trade intraday.”

Haynes said that the FCA was also moving the UK market closer to global norms.

“In the US, for example, there have long been strict limitations on daily-dealing open-ended mutual funds investing in illiquids and, as a result, over nearly 50 years and across many thousands of funds, there have hardly ever been instances of fund suspensions. Similarly in Germany, where they experienced lockups to bricks and mortar property funds during the 2008 Great Financial Crisis, the regulator moved quickly and decisively to implement new rules not dissimilar to what is being considered by the FCA today and by all accounts it has been very successful,” he said. 

Kay Ingram, director of public policy at financial planners LEBC, said: “The [FCA] proposal that investors should give of up to six months’ notice to facilitate a redemption appears to be a sensible and practical way to avoid funds having to close at short notice and for extended periods due to liquidity issues.”

“For the retail investor, bricks and mortar property funds should only form that part of their portfolio to which they do not require easy access with other more liquid funds being available for emergency and short-term spending. It may be necessary to waive this notice period for property funds held in estates as HMRC would normally require any IHT to be settled within this timeframe and executors could not gain probate prior to settling any IHT,” Ingram.

James McManus, chief investment officer, Nutmeg, said: “For many professional investors, it won’t come as a surprise that the FCA is looking to take action on the mismatch between the promised liquidity of open-ended property funds and the liquidity they offer in reality – what is surprising is how long it’s taken. The issue of the liquidity mismatch and the suitability of these investments for retail investors has been a long time in the making, as the industry has refused to take meaningful steps to protect consumers. The coronavirus pandemic and subsequent gating of property funds has once again highlighted the issue, but it is not the first time retail investors have been unable to redeem money from investments marketed as having daily liquidity.”

Mergers
The FCA said that its proposed notice period will give managers scope to plan sales of property assets and meet redemption calls, as well as make the market work more efficiently.

‘We think that our proposals will help further our consumer protection objective by reducing the number of fund suspensions, preventing unsuitable purchases of funds, and by increasing product efficiency for fund managers,” Christopher Woolard, interim chief executive of the FCA, said.

“We want open-ended funds to provide a structure through which investors can safely invest in less liquid assets which offer attractive expected returns and at the same time supports investment that benefits the wider economy,” Woolard said. 

The FCA will publish a policy statement with final rules as soon as possible in 2021. The consultation remains open until 3 November.