Bad Brexit: How will property funds react?
The measures needed to make investors feel safe as houses
Property is an asset class that some retail investors understand better than others, but it brings its own risks as well as some substantial benefits.
Many investors already have exposure to property through their main residence, and commercial property is frequently a constituent of diversified portfolios.
It is easy to visualise and it offers a relatively attractive and stable income stream. Perhaps most importantly, it brings diversification relative to bonds and equities.
Property sector doubles cash amid industry's liquidity crisis
Unfortunately, it also carries risks. Some are tangible, such as the risk of income falling, or of a property slump leading to lower capital values and yields, but one is dependent on how we invest in it.
Commercial property is perhaps the least liquid mainstream asset class and yet most retail investors access it through daily dealing open-ended funds.
The mismatch of putting an illiquid asset class in a daily dealing vehicle is well-documented but it is likely to come under scrutiny in the coming months.
Prior to the 2016 referendum, a game of chicken was being played in property funds. They offered attractive yields, but investors knew a bad Brexit result could lead to problems for property markets.
Everybody wanted the yield, but nobody wanted to be the one left in after others had taken their money out, knowing this could lead to funds suspending trading.
For a while there was a stand-off, but then a few big players decided the risks were too high and started to take money out.
The following weeks saw a very quick escalation in risks, with a fall in property values in the UK and worsening investor sentiment leading to significant outflows of retail money.
Property funds under increased FCA scrutiny ahead of Brexit deadline
Many funds swung their prices to a cancellation basis, reflecting greater outflows than inflows. The impact this had on the price of each fund varied but was generally around 5%.
Many funds applied a fair value price adjustment, further reducing the price of their funds by 4% to 5%.
These measures, however, did little to stem outflows and several funds suspended trading to enable them to sell properties in an orderly fashion.
Those funds that did not close applied increasingly large fair value adjustments - some well over 20%.
Most remained suspended for several months, only re-opening when they had significantly increased their levels of cash.
Deadline looms
As 31 October approaches, it is worth assessing the situation. Currently, all retail open-ended property funds remain trading.
At least one institutional fund has closed, but this has not had much impact on the retail market. Property yields have fallen since 2016, with the market having seen some very decent returns.
For now, there is uneasy stability in the market.
However, the uncertainty in the lead-up to the Brexit deadline feels familiar. This could easily spook investors and it would not take much to turn jitters to fear, causing a run on property funds.
Markets are slowing and prices being marked down, adding to concerns. Many investors' mindsets have turned to playing safe and that can be self-fulfilling.
But there are several differences between the situation today and around the time of the referendum, which could create a different outcome.
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