The recent news that M&G Investments have chosen to suspend dealing in their UK Commercial property fund has once again caused consternation from numerous commentators as there will be a an indeterminate period in which investors in the fund will not be able to redeem or trade units. It has been applied because of increased withdrawals from the fund due to Brexit-related uncertainty.
Property in various forms has been an important part of many of our portfolios since their inception in April of 2009 but our latest investment model portfolios now hold no singular property funds (we retain one multi-asset US listed real estate fund). So why have we changed our opinion on these assets?
The most pervasive property vehicle within our more defensive funds has been in direct commercial property, based in the UK. The attraction of these funds has conventionally been in obtaining a healthy, steady income stream from an asset that doesn’t correlate with equity or bond markets. The diversification element of this has been very important, especially in times where equity and bond markets correlate positively, such as during the ‘Taper Tantrum’ in 2013, when the Federal Reserve announced their planned curtailing of their quantitative easing (QE) programme. This is because the assets that these funds hold are not changing value on a daily basis and are beholden to factors such as demand (for offices, warehouses, retail lots, etc), supply (of the same), employment, wages and bank lending rates and their values move more slowly, being valued every month, rather than every day. This has made property funds very useful in terms of capital preservation.
Since the EU Referendum in 2016, the outlook for property as an asset has looked less attractive to us. Direct commercial property funds have offered less value in recent years and yields available from them are generally below 3% today and capital values have been slowly deteriorating. This makes these assets less attractive from a return point of view and they also hold an additional liquidity risk. Commercial properties deals are difficult and can take some time and therefore if numerous investors wish to relinquish their holdings at the same time there can be an issue fulfilling these requests. This has led to funds temporarily suspending dealing while liquidity is improved and cash is raised from sales. This impacts on the ability to trade a portfolio and can lead to delays in other switches within a portfolio. In times of stress these funds can also significantly reduce the valuation of the fund as they may not be able to achieve the full value of their assets in a distressed sale situation. We see this as a risk in the near future, for example if we saw a difficult Brexit, and do not believe that this potential disruption risk is offset by the relatively low returns on offer.
While this relatively significant decision has removed direct property from our portfolios, we do retain some exposure. Some US-focused property bonds and equities related to housing as well as some UK infrastructure (including doctors’ surgeries, government buildings and student housing) are still important components of our portfolios and provide solidity as well as income.
We have replaced our direct commercial property holdings, in the majority of cases, with low-risk, short-dated bonds that will provide a similar, if not superior, yield but do not expose us to liquidity issues or interest rate risks. These assets have low levels of volatility and tend to be robust in times of stress. We can be assured that the security of income certainty and lack of correlation with other assets in portfolios will be maintained.
By Tom Sparke, Investment Manager