Time's Up For Property Funds

Editor's Views: Property funds are not fit for purpose, and why greedy managers should pass on the economies of scale to their investors 

Holly Black 6 December, 2019 | 10:08AM
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Are open-ended property funds fit for purpose? I fear not.

This week M&G suspended its property fund from trading amid liquidity fears. With a General Election just days away and Brexit supposedly next month, I would be surprised if it were the only fund to shutter its doors in the coming weeks.

Property funds face an inherent Catch 22. They must hold cash in case of investor redemptions, but the cash they hold is not generating a return and is, therefore, not serving investors.

As our investigation this week reveals, just one open-ended property fund rebates some of its fee to investors if its cash levels get too high. That’s not good enough. If people are paying you to invest their savings and you aren’t, they should get their money back.

But it’s pretty much a lose-lose situation – because if a fund does invest the money rather than hold cash, it could be forced to suspend trading when things get hairy. Either way, investors lose out: either by paying for a service they’re not getting, or by being refused access to their money.

Time and again it has been proven that holding illiquid assets in a daily dealing fund is just not appropriate. We saw with Woodford earlier this year how that can blow up when investing in private companies, and this is not the first time the issue has reared its head in the property sector.

Buildings take months to sell and fund investors want the ability to buy and sell daily – it just doesn’t fit. How many times must we go through this before asset managers admit that property funds just don’t pass muster?

Tiers Save Tears

Funds not passing on the economies of scale is one of my biggest bugbears about the industry (and there are many to choose from). This is the idea that as a fund grows in size, the costs of running it do not grow at the same rate and companies should pass on some of those savings to their investors. This is not difficult to execute, all a fund needs to do is scale down its charges as its assets grow. 

Trade body CFA UK has come to the same conclusion: tiered fee structures are relatively simple to understand, they are transparent, and they are fair. (The firm reviewed about nine different charging structures - there are NINE!? - but that's a rant for another day)

If a fund's assets grow from, say, £1 billion to £10 billion and it continues to charge the same 1% annual charge regardless, it’s revenues rocket from £10 million to an unfathomable £100 million.

At best this is greed, at worst it is profiteering – and it wouldn’t be allowed in any other industry.

With tiered pricing, fees are charged on a sliding scale as assets grow. It's not perfect but it's a step in the right direction. Crucially, it means managers aren’t incentivised to keep growing their fund to the detriment of performance.

A number of fund firms and investment trusts are starting to recognise the importance of passing on the economies of scale. Baillie Gifford, M&G and JPMorgan are just some of the firms who have implemented this structure on some of their products.

But where are the rest of them? What about these behemoth funds with £10 or £20 billion of assets under management? Some say their performance merits the fee – I disagree.

Come on Mr Regulator, insist that the rest follow suit.

Politics Could Disturb the Santa Rally

The investment industry, we know, loves a pointless adage and December is no different. So, what do you think - will we see a Santa Rally this year

Yes, the season of goodwill is not only a great time to eat mince pies, somewhat counterintuitively, it's also often a very good time to be an investor. Over the past 50 years, the investment elves have been hard at work and the UK stock market has risen in three-quarters of Decembers. 

The jury's still out for December 2019. With a General Election coming to town a couple of weeks before Santa does so, I'm expecting some volatility. Investment folk seem to think anything but a Boris victory will be bad for the FTSE, and those who think the Tories will secure a majority are buying up the pound. Me? I think I'll stick to trying to guess what's under the Christmas tree, rather than what's going to happen on the stock market. 

The information contained within is for educational and informational purposes ONLY. It is not intended nor should it be considered an invitation or inducement to buy or sell a security or securities noted within nor should it be viewed as a communication intended to persuade or incite you to buy or sell security or securities noted within. Any commentary provided is the opinion of the author and should not be considered a personalised recommendation. The information contained within should not be a person's sole basis for making an investment decision. Please contact your financial professional before making an investment decision.

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About Author

Holly Black  is Senior Editor, Morningstar.co.uk


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