The Risks of Investing in Property Funds
St James’s Place, the largest financial advisory firm in the UK, has made the decision to completely close its property fund, returning capital to investors over a year after its suspension.
During this 14-month period, investors have been subject to a reduced fee while their investments were essentially frozen. This situation is set to continue for approximately two more years as the fund is unwound.
This predicament is undoubtedly frustrating for the 120,000 individuals whose investments remain inaccessible. However, one must question whether placing funds in a property investment vehicle was appropriate to begin with.
A property fund typically consists of a diverse array of physical assets, including offices, hotels, shopping centers, and warehouses. Returns are generated through property value appreciation and rental income from occupants.
The primary advantage of investing in such a fund is the flexibility of buying or selling shares without advance notice. Fund managers manage withdrawals by selling off a portion of the assets. However, this fluidity does not hold when it comes to real estate, which can take considerable time to sell, unlike more liquid assets such as stocks.
In times of financial uncertainty, property funds may suspend trading to prevent forced liquidation at unfavorable prices. This suspension can last for various durations, leading to the permanent closure of the fund.
The trend of property fund suspensions is not new. Since 2021, notable firms such as Aegon, Aviva, M&G, Janus Henderson, and Canada Life have all dissolved property funds. The COVID-19 pandemic saw several suspensions, with others experiencing similar actions following the Brexit vote in 2016 and during the 2008 financial crisis.
In contrast, property investment trusts avoid this scenario due to their fixed share structure, allowing shareholders seeking exit to sell on the market without needing the fund to liquidate assets. However, this can lead to significant drops in share prices during market downturns.
There is considerable evidence indicating that open-ended property funds do not effectively meet investor needs. Offering immediate liquidity on inherently illiquid assets like real estate presents significant challenges.
While one should not solely fault open-ended property funds, the entire concept of investing in property funds raises valid concerns.
Real estate investment captures the public’s imagination — from the aspiration of home ownership to rental properties and vacation homes. According to the Office for National Statistics, property represents over half of individual wealth.
This substantial investment can lead to a risky overexposure to real estate. Many still maintain the reassuring notion that “you can trust bricks and mortar.” However, recent performance data contradicts this belief, revealing that average UK direct property funds declined by 2.2 percent in the last three years, while broader equity funds posted gains of 10.8 percent and 17.8 percent globally.
It appears that investors are catching on, as property funds have witnessed net outflows in seven of the past eight years, with a reported withdrawal of £644 million in the previous year alone, though approximately £19.8 billion remains invested in this sector.
The Financial Conduct Authority has acknowledged these challenges related to property funds and conducted consultations to explore potential solutions.
Among the proposals discussed is the concept of “long-term asset funds,” which would limit investor access to their funds at specified intervals rather than daily. However, this could exacerbate issues by creating a rush to sell during tumultuous times when access is restricted.
Experts have also suggested “hybrid” property funds that would invest in both physical properties and shares of property-related companies. While this approach may enhance liquidity, it raises questions about truly diversifying one’s investments, as both types of assets can decline in value during downturns.
While some argue that even minimal property investment provides diversification, alternatives such as infrastructure, commodities, and renewable energy may offer better prospects.
Homeownership is certainly worthwhile, and investing in additional properties can be appealing. However, it’s essential to recognize that many individuals are already heavily exposed to the volatility of the property market, without the need to amplify this exposure in their ISAs and pension funds.
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