Fund liquidity - UK property fund closures

Jason Baran, Insight Analyst (Investments)

Do investors think about fund liquidity? The issue of liquidity and lack thereof re-emerged following the result of the Brexit referendum with the closure of seven leading UK property funds. (NB: as of writing 6 of these funds remain closed, one has re-opened with valuation adjustments.)

The search for yield has pushed many investors further along the risk spectrum. Whereas before risk averse investors may have predominantly invested in low-risk fixed income assets, at current quantitative easing-inspired valuations this doesn’t make sense for any investor that is looking for an income.

The basic premise of risk vs. return is well established. However, as a bull market endures and momentum gets into swing, investors tend to forget the previous market panic; it can become easy to extrapolate risk and returns from recent history. This can lead investors to invest in assets where they are not being fully compensated for all the risks they entail, of which those involved with property investments are several. For example, we can break property risks down into various inflation, regulatory, economic, credit, market, counterparty and liquidity components.

The Brexit vote has increased uncertainty around the first 4 of these risk factors, but liquidity risks should have been apparent from the beginning. A quick consideration of the types of assets invested in, i.e. large scale commercial property frequently valued at multiple tens of million pounds, and it shouldn’t take much understanding to grasp that selling one of these units may take some time. Very likely, these funds may be closed for weeks or months while new property buyers are found and transactions completed.

To go a step further, these risks are always clearly explained in the KIID (Key investor Information Document) as published for each fund by the fund provider. This is a regulatory requirement and liquidity risk is usually top of the list.

There are some alternative vehicles to invest in property and maintain liquidity. Investors can choose to invest in closed ended funds, in which case it is possible to sell fund units but expect this to be at a discount in the event of a market shock. In other words, an investor can exchange liquidity risk for market risk. It is up to the investor as to whether this is acceptable, but at least some of the investment is accessible when it’s needed. A closed end fund could be in the form of a property investment trust in the UK, or as they are better known globally, a REIT (Real Estate Investment Trust).

While the Brexit result was a surprise to most, and some investors were caught off guard by the closure of these funds, investors should have been aware of property’s risks before investing. Property can provide diversification and returns, but investors should pay attention to the risks as well as the yield.