Allan Miller, founding partner and CIO at UK asset manager SCM Direct, has said in his latest blog posting that UK open ended property funds could be liable for compensation payments of £140m because of the losses imposed on investors by failures to properly address the liquidity crunch that has hit the sector.
Miller writes that SCM warned UK regulator the Financial Conduct Authority on Monday 27 June that physical property funds needed to reprice or suspend trading in their own shares. This is an issue that SCM has pursued with the regulator for the past year – and yet still it failed to ensure that investors were treated fairly in accordance with Treating Customers Fairly (TCF) requirements.
“SCM Direct has been highlighting this serious liquidity issue in retail property funds since August 2015. Yet neither the FCA nor the fund groups ever properly addressed this issue?” Miller writes
“How can you run and market a fund purporting to offer investors daily liquidity when typically, 80-90% of the fund is locked up in illiquid investments that might take several months to sell in a downturn?”
Miller said that SCM telephoned the FCA Market Abuse line on 27 June to warn of “material over-valuations within many major property fund groups and recommending either funds to be suspended or re-priced to reflect reality of comparable listed property stocks post Brexit”.
The problem was caused by the fact funds marketed as offering daily liquidity to investors were themselves invested in highly illiquid assets. When share prices in companies such as British Land collapsed immediatedly following the referendum vote, it followed that investors would expect the value of the property holdings in the open ended funds to fall. Yet this did not happen immediately, but took almost two weeks before funds significantly marked down the value of their holdings and/or stopped investors from exiting.
“The fundamental question has to be whether or not these groups met at all their requirement to Treat Customers Fairly (TCF)? All firms regulated by the FCA ‘must pay due regard to the interests of its customers and treat them fairly’. The TCF principle aims to raise standards in the way firms carry on their business by introducing changes that will benefit consumers and increase their confidence in the financial services industry. By doing nothing, investors redeeming were almost certain to be selling their units at a materially inflated price, subsidised by the remaining holders in the fund.”
“Should these funds be forced to compensate the fund for transactions they allowed to take place at inflated prices, between the Brexit vote and the time of their suspension? If yes, at what level? If we assume that c. 10% of these funds were redeemed prior to suspension or 15%+ price adjustment, at prices potentially c.10% too high, it has cost the other investors in… eight physical property funds alone c. £140m directly (the eight funds being worth close to £14bn).”