ii responds to FCA consultation on open-ended property funds

We believe that better disclosure is needed and more transparency put in place.

• Calls for fixed redemption periods which are long enough to address the issues at hand  
• Requests clearer disclosure for investors 
• The role of investment trusts still overlooked by the regulator

interactive investor, the UK’s second largest direct to consumer investment platform, responds to the FCA’s consultation on the liquidity mismatch in authorised open-ended property funds (the deadline closed yesterday).

While FCA efforts to tackle liquidity issues within property funds can only be a good thing, there is no perfect solution for a structure that is not ideal for investing in illiquid assets. These measures alone will not resolve the issue, and interactive investor is calling for additional procedures to ensure [retail] investors are not burned, yet again.

interactive investor believes that the redemption period should be fixed, so as not to cause confusion for investors, and significantly long enough to ensure there is time to address the liquidity mismatch.

More broadly, around the issue of illiquid assets, interactive investor is also calling for better disclosure. Rather than focussing on how much a fund is permitted to invest in illiquid assets, the platform would like to see regular communication of how much, in percentage terms, a fund has invested in illiquid assets. 

Moira O’Neill, Head of Personal Finance, interactive investor, says: “Time and again, property funds have failed the stress test – whether that’s the UK referendum four years ago or the brutal reality of Brexit headwinds and a High Street in terminal decline. There’s no guarantee that the FCAs proposals will solve the issue entirely and we would suggest investors keep an open mind and consider alternatives.

“While the FCAs’ proposals go some way to resolving the liquidity mismatch, the role investment trusts can play is still being overlooked. Trusts come with issues of their own, but they are still a better option, in our view, for investing in illiquid assets like property. Yet they are mentioned only once in the consultation paper by the regulator, and only in passing, as an alternative means of accessing property. It does raise the question of whether the FCA is overlooking the existing secondary market in property investment trusts – funds are not the be all and end all.”

This is echoed by Annabel Brodie-Smith, Communications Director of the Association of Investment Companies (AIC), who says: “Notice periods are a step in the right direction but the arbitrary 90/180 day period does not go far enough. The basis on which an investor can leave an open-ended fund should not change, regardless of the market conditions or level of redemptions. In Germany, property funds have a one-year notice period and they have won the confidence of investors, with the sector seeing inflows in recent years, even during the pandemic.

“Contrast this with the net outflows from UK property funds – outflows which would have been greater had most of the sector not been suspended for most of this year. Investment companies have an important part to play in helping investors access illiquid assets like property within a suitable structure. Investment companies’ closed-ended structure means managers don’t have to worry about inflows and outflows and their stock exchange listing means investors have the freedom to sell their shares whenever the market is open.”

Longer and fixed redemption periods

interactive investor believes giving fund managers the flexibility to set their own redemption period of between 90 and 180 days creates confusion for investors. 

A longer redemption period may help restore investor confidence in the real estate funds sector as seen in Germany where the regulator Bafin requires investors to give 12 months’ notice to redeem units in open ended property funds. 

Should FCA decide that 180 days is a reasonable compromise, a formal post-implementation review should be incorporated into the policy statement, with the specific aim of reviewing whether 180 days is working. 

ISA eligibility 

The potential impact on ISA-eligibility for existing investors and potential buyers is another important consideration highlighted by interactive investor in its response to the FCA – and is something HMRC launched a separate consultation on at the end of October. 

ii believes that if holdings must be sold or transferred out of the ISA wrapper, existing investors are immediately at a disadvantage. 

Similarly, if there are significant pending redemptions, a fund’s ‘value’ becomes misleading due to the time it takes to sell properties within the portfolio. Buyers could potentially be making an investment at a price that does not reflect the true value of the fund – which means they could stand to lose out financially.  

Interactive investor is calling for investors to be made aware of this issue by way of appropriate disclosure, and for HMRC and the FCA to agree a position that means existing investors are not disadvantaged in this manner, even where future investments are not ISA-eligible. 

Disclosure

interactive investor understands that the FCA intends to explore further the subject of open-ended funds investing in illiquid assets and welcomes this. It would encourage the FCA to consider whether disclosure goes far enough, in terms of telling investors how much of the fund is currently invested in illiquid assets, as opposed to a more generic disclosure around how much the fund is permitted to invest in illiquid assets. 

The FCA should also consider whether redemption periods should be applied to funds investing in illiquid equities.