It’s just over a year since a shock referendum result led to gatings and price adjustments at almost every open-ended property fund. Now that the fuss has died down and the gates have reopened, we might wonder how much it matters. After all, investing in property should be about the long term. So what if funds need to suspend trading temporarily if it’s to protect the returns of all investors?
There’s a couple of problems with this argument. First, the ‘gating’ happens at the very moment when you might want to sell to protect a client from further losses – and surely that should be your call. But even if we accept that gating is a reasonable price to pay to protect long-term returns, the problem remains that the long-term returns still aren’t very good.
The 10-year return of the average open-ended fund in Morningstar’s Property Direct UK sector is 14.3 per cent to 30 June. The IPD UK All Property index return is 46.6 per cent, but that’s hardly a fair comparison as it doesn’t include costs. Closed-ended property funds in the same Morningstar sector, though, managed 24.8 per cent on an NAV basis (and more on a share price basis). In fact, closed-ended property funds have also outperformed open-ended ones over one, three and five years, whether you look at share price returns (the returns actually received by shareholders) or NAV returns (the returns of the underlying portfolios).
The message seems clear: for a lumpy asset like physical property, the open-ended structure just doesn’t work very well. You only have to look at the weighty cash holdings of these funds, often around 20 per cent, to understand why results have been underwhelming. So it’s surprising, to say the least, that there is well over £20bn of retail investors’ money languishing in the open-ended structures, but barely a quarter of that sum invested in closed-ended property funds.
That’s not to say last year’s experiences have made no impact. In the third and fourth quarters of last year, the closed-ended Property Direct – UK sector saw a higher volume of purchases on adviser platforms than any other sector, according to data from Matrix Financial Clarity.
But old habits die hard. There are still a couple of arguments we hear put forward as to why open-ended property funds should be preferred to their closed-ended counterparts.
The first is that you hold property for diversification. Closed-ended funds, being equities, behave somewhat like equities. But they still offer reasonable diversification benefits. Over the past 10 years, the closed-ended property funds in the Property Direct – UK sector have shown correlations of between 0.31 and 0.41 with the FTSE All Share.
The second counterargument is that while open-ended funds experience the odd gating, closed-ended funds have discounts and premiums that can move against you. The feeling seems to be that it’s six of one, half a dozen of the other. But that depends on your time horizon. Over time, discounts and premiums tend to mean-revert. They are the ‘pressure valve’ that allows investors to exit without taking chunks of value out of the portfolio. The liquidity mismatch inherent in open-ended property funds erupts every now and again in flurries of suspensions, but that doesn’t mean that the rest of the time, it isn’t a problem. Fund flows and cash drag chip away at returns day in, day out.
It may be that the real risk of open-ended property funds is not the dramatic, headline-grabbing one of gates slamming shut. It’s more the risk you’ll look back in 10 years’ time at returns so anaemic you’ll wonder why you bothered.
Nick Britton is head of training at the Association of Investment Companies