The Financial Conduct Authority (FCA) wants to even up a liquidity mismatch in open-ended property funds. Hear, hear.
With property funds needing to be suspended more frequently over the last decade – and interestingly the FCA notes suspensions “generally work” – this may incentivise some investors to redeem ahead of others, possibly disadvantaging those who remain.
To level things up, in CP20/15 it is proposing investors notify fund managers in advance when they wish to redeem. How far in advance? Currently, the proposal is for somewhere between 90 and 180 days. Easy math: that’s up to six months.
This is an important, progressive piece of work, but it could lead to profound change – for asset managers, platform operators, financial advisers, and investors.
The question is: what is the right thing to do?
Here I have outlined three outcomes we believe the FCA must address. We start with what may be the most pertinent…
This is a real concern. Retail investors must be able to access property, including within an ISA. The regulator needs to be careful its proposed actions do not inadvertently remove this access from mainstream financial planning.
Property offers some unique benefits to investors, including access to assets they could never buy directly, and a low correlation to both shares and fixed income.
And it isn’t only retail investors who would stand to lose out in this scenario, but UK infrastructure itself. What would happen to this central pillar of the economy if a significant stream of investment were shut off?
Some are reasonably asking whether CP20/15 heralds the death of property as a standard component of model portfolios. They posit that direct holdings, possibly off-platform, may help solve the liquidity crisis.
Of course, this would have implications for advisers, adding complexity to the advice process and increasing their administrative burden, particularly around reporting.
So, it is worth reiterating: retail investors must be afforded access to property.
Should the inherent risks of investing in property be made more visible to retail investors? They absolutely should.
Property fund concerns are not a new phenomenon. In fact, the liquidity challenges we are trying to fix today have existed since open-ended property funds arrived more than 30 years ago.
Property funds were gating in 2008, during the financial crisis (New Star International Property, anyone?), and again in 2016 following the Brexit vote. In many ways, this is old ground.
So, the question may simply be: do retail investors fully understand what they are getting into when they invest in property?
Humans are drawn to lists – this article is a list – so it should come as no surprise that we also list traditional asset classes, in order of capital risk.
You know how it goes: it starts with equities, ends with cash, and lumps property and fixed income in the middle, in that order.
It’s simple and makes for a straightforward conversation with clients.
But are we unintentionally masking some wildly different risk characteristics that exist between asset classes?
It may be time to bring these risks to the forefront.
Of course, if we make the risks with property more transparent to retail investors, where will responsibility for flagging these risks sit?
Naturally, this is less of an issue on an advised book, but it is significant to non-advised investors. Which brings us to our third outcome…
Property can be a highly illiquid asset class, and as we have seen property values can be difficult to assess. These are significant risks.
But we believe it should be recognised that an advised portfolio, or one managed by a discretionary manager, involves a professional who is weighing these risks.
A financial adviser understands the risks of investing in property and the implications of gating. The extent to which these risks are explained to clients – and how problems are handled when they arise – will differ, but there is a layer of protection for advised clients.
This is very different to a retail investor making their own decisions.
Whatever the outcome of CP20/15, with a potential time-bar on redemptions, and continued daily pricing, the technology is going to have to be water-tight to cope.
We might also ask, if it is the FCA’s intention for property funds to remain available to retail investors, what are the operational impacts to platforms and advisers using them?
Next steps? CP20/15 closes to consultation in early November. Any new rules are unlikely to be shared until next year, with possibly six months to implement. So, there is time to consider the options and reach the best outcome for all.
Alistair Wilson is head of platform strategy at Advance by Embark Group