Why this fund sector is not fit for purpose

Uncertainty over the future of open-ended property funds has prompted this asset manager to seek a buyer for its fund.

Janus Henderson has suspended its £1 billion property fund amid uncertainty over the future of open-ended property funds.

The asset manager is seeking a buyer for its physical property portfolio, Janus Henderson UK Property PAIF and its associated feeder fund. It says the fund suspension will give a sale the best chance of succeeding.  

The fund firm said that “the ongoing uncertainty in the UK over the future of open-ended funds invested in direct (physical) property within a daily-dealing structure has contributed to persistent net redemptions from the PAIF”.

It added: “This has reduced assets under management materially to the point of challenging the portfolio’s future shape and quality, along with expected returns to investors.”

Simon Hillenbrand, head of UK retail at Janus Henderson, said: “Having researched a number of options, we believe the best solution is to promptly execute the sale of all of the Janus Henderson UK Property PAIF’s property assets to a single buyer.

“The net proceeds will then be distributed to investors according to their holdings in the PAIF and its feeder fund.While we cannot currently provide a firm completion date, we are optimistic that a sale could be finalised towards the end of March/early April.

“Proceeds should be able to be returned to investors by the end of April. We believe it is in the best interests of investors in the fund that we take steps now to secure the best outcome for them.”

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The future of commercial property funds is up in the air, with a flurry of fund suspensions following the Covid-19 pandemic prompting the Financial Conduct Authority (FCA) to consider new rules.

The proposed new rules to address the liquidity mismatch of open-ended property funds (see below for explanation) could spell the end of the current daily dealing structure. One option being considered is the introduction of notice periods of up to 180 days, meaning that investors would be able to sell only twice a year.  

In addition, a new type of fund structure was given the green light last November. The Long-Term Assets Fund aims to enable efficient investment in illiquid assets. Such funds will have a minimum 90-day notice period for withdrawals and could be a good fit for physical property. However, retail investors are not currently allowed to buy the funds and they are instead being aimed at sophisticated investors and defined contribution pension schemes.

History repeats itself, again

While investors are told that ‘past performance is no guide to the future’, when it comes to commercial property funds invested directly in real estate, there are sound reasons why history will keep repeating itself.

Under normal market conditions, although it can take months for such funds to buy and sell the shops, offices and factories held in the portfolios, it is not a problem for investors to withdraw their cash on a daily basis, as a portion of the portfolio remains in cash.

But, during times of heavy selling, the cash buffer is depleted, which makes it difficult for open-ended commercial property funds to meet withdrawals on a day-to-day basis. Since property sales are not quickly or easily arranged, particularly in times of market uncertainty, it is very difficult to raise money quickly and this creates a liquidity mismatch.

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To halt outflows and avoid selling assets at knockdown prices, which would negatively impact investors who remain invested, fund management firms move to temporarily restrict or bar investors from accessing their cash. The global financial crisis and the Brexit vote in June 2016 are two examples of when this has occurred.

In response to fund suspensions following the EU referendum, property funds raised cash levels in an attempt to avoid future fund suspensions during times of market stress. However, higher cash weightings (with cash positions typically ranging from 15% to 30%) did not have the desired effect.

Bear in mind that higher cash weightings are a drag on a property fund's performance and lower its dividend yield. In addition, most funds do not reduce their fund charges to take into account the higher cash weightings. 

Investment trusts, due to their closed-ended structure, are not under the same pressure to react defensively when investors take fright. Trusts have a fixed level of capital, so they do not need to sell the properties they own.

Instead, investors who wish to sell simply dispose of their shares, although this may be at a lower level than desired if other investors have rushed to the exits and sent the share price tumbling.

Discounts will also likely widen, and gearing can also hurt in a downturn. However, the structure means the fund managers are not forced sellers and investors are not barred from accessing their cash.