After the “Brexit” vote in the United Kingdom, some of the most popular property funds have faced heavy outflows, since investors expected property prices to fall in the aftermath of the referendum. These outflows have been so high that the funds can’t pay investors back with the cash held in the portfolio. As a result the funds have been closed to redemptions to protect all the investors from possible losses.
The closure of a property fund may lead to massive disappointment for investors, since some of them may need regular payments from these products to make their living (at least partially), and they are now in trouble. Other investors might simply not be aware that funds can be closed to redemptions and may now have lost their trust in the mutual fund industry.
Since we had already experienced a similar situation in Germany, where property funds were closed in the aftermath of the financial crisis of 2008, I am wondering whether the European fund industry has learned nothing from that lesson. Property funds have an implicit mismatch in investment horizons: properties themselves are not tradeable on a daily basis, while property funds offer daily liquidity to their investors.
The daily liquidity causes the trouble by its nature: since property funds are often sold without any front-end or exit fee, these funds have been used as cash equivalents with high returns. Since cash should be a low-risk asset class, it is understandable that investors want to get out of these products in a market environment that causes heavy losses to these products.
This investor behavior may lead to even higher losses; the funds hit by these redemptions have to sell some of their properties to fulfill their liquidity needs, and since all market participants know the funds have to sell, that puts the funds in a weak position for negotiating a price for the properties.
In this regard one may see property funds as a threat for the investment industry and may question if properties should be an eligible asset class for mutual funds. I assume regulators will be taking a closer look at this product type, since this has happened now for a second time since the financial crisis.
Nevertheless, there are ways to make these products more resilient against market crises, as has been shown by German regulators who introduced new guidelines on property funds to align the investment horizons of the investors with the natural investment horizon of the underlying assets.
As a result, property funds have not only survived as an asset class in Germany, they now enjoy healthy inflows. That shows there is a demand for these products and that investors are willing to accept limitations on the liquidity as long as they understand the rationale behind them and can still trust the overall system.
Detlef Glow is head of EMEA Research at Thomson Reuters Lipper