Removal of Bricks & Mortar Commercial Real Estate

There are two types of commercial property funds which are generally available to investors. The first, and oldest, form might be described as a ‘direct’ property fund. Direct property funds invest in real ‘bricks and mortar’ properties like shopping centres, warehouses and offices. The second, newer, ‘indirect’ form invests in the shares of listed property companies like Land Securities Group which own and operate large real estate portfolios.

We’ve long advocated the use of open-ended ‘direct’ property funds as a part of a diversified portfolio. There are, though, a few developments which have led us to review our position.

The first is the frequent suspensions in trading that have been imposed in recent years. Ordinarily, trading suspensions are nothing to be concerned about. They are a legitimate tool used by fund providers to manage fund redemptions (encashments) in the best interests of long-term investors. In our estimations though, such periods of suspension are becoming more frequent. That makes it more difficult to manage our clients’ portfolios effectively, even though property funds make up just a small part of the overall portfolio.

The second development sees our regulator – the Financial Conduct Authority or FCA – currently conducting a review into these kinds of funds, the outcome of which may be the mandatory imposition of a 90 or 180 day notice period. We have no objection to that in principle, but we do think that the transition to any new terms will encourage large scale redemptions ahead of them coming into force. That in turn may trigger more trading suspensions.

The third and final development, which may be related to the first two, is that several large fund management groups – AVIVA and AEGON for example – have announced that they are closing their property funds. We suspect that more will follow.

We still think that commercial real estate has a place in our client’s portfolios. That is why are exploring the opportunity for replacement investment in a fund which secures that investment in an ‘indirect’ form. Such funds are much more volatile than the ‘direct’ form but they generally are not vulnerable to trading suspensions.

Given the relatively small part that property exposure plays inside our range of portfolios it is our judgement that the small aggregated increase in risk at the portfolio level associated with a shift from ‘direct’ to ‘indirect’ is worth the benefit of avoiding those trading suspensions.