Today the Association of Investment Companies (AIC) published ‘Don’t let the tail wag the dog’, its response to the FCA consultation ‘Liquidity mismatch in authorised open-ended property funds’ (CP20/15).
The AIC argues that a 12-month notice period is required to protect consumers and the economy from the risks arising from open-ended property funds. This approach is taken in Germany, where property funds have seen sustained investment before and during the COVID crisis, as opposed to the UK which has seen sustained outflows and lengthy suspensions.
The Association welcomes the decision to use notice periods to protect investors (a key recommendation in its earlier paper, ‘Square peg in a round hole’) but believes that the FCA should follow the evidence and not allow other considerations to influence its decision on the length of the notice period.
Ian Sayers, Chief Executive of the Association of Investment Companies (AIC), said: “Notice periods for property funds will only work if they are set prudently and can cater for all real-life situations. The evidence is that 180 days is not enough. Without proper standards, funds will still need to hold high levels of cash, sell assets in a fire sale and be vulnerable to suspension.
“The FCA’s priority should be to protect consumers and it should not allow considerations such as the length of notice periods on cash deposits to influence its decision. The FCA should adopt the German property fund model, which requires a 12-month notice period. This has meant that funds have operated as promised, without suspensions, and the sector has seen sustained investment even during some of the most difficult markets we have ever seen.”
Evidence for a longer notice period
Research by property experts, and cited by the FCA, found that 40% of transactions would take longer than eight months – significantly longer than the maximum notice period being proposed by the FCA. But this evidence still underestimates the time it could take property funds to sell properties to pay back investors.
- The research does not consider the full length of time it takes a fund to raise cash from property sales to meet redemptions. The clock starts for a fund when the manager realises that redemption pressure requires it to sell properties. This is earlier than when a property is first listed for sale, or actively marketed.
- The research does not reflect aborted sales transactions. These are a fact of commercial life and greatly increase the time it might take to sell a significant part of a property fund’s portfolio to meet redemption pressures.
- Transaction times lengthen in more difficult market conditions. International standards require redemption terms which can handle ‘stressed market conditions’ without the need to suspend the fund. This must include periods such as after the Brexit referendum and late 2019, both times when UK property funds were suspended.
- The research considers property transactions in general, rather than in relation to an individual fund. As Woodford Equity Income Fund demonstrated, initial redemptions consume cash first and then the most liquid investments next. If redemption pressure continues, remaining investors are increasingly exposed to investments that take longer to sell. It is not good enough for the notice period to allow an exit for investors who choose to leave first, leaving the rest exposed to the risks of suspension. The rules must protect everyone.
- A notice period needs to cater for all types of property funds. A fund holding attractive logistics properties may have a very different ability to meet a 180-day notice period than one specialising in, say, shopping centres.
The AIC also questions the FCA’s consideration of issues such as notice periods on cash term deposit accounts when setting notice periods for property funds. Cash deposits carry no risk to capital and one account holder’s decision to withdraw their money does not prejudice remaining deposit holders.
