Now, with some of those redemption halts going into their third month, a debate has surfaced in the industry between the firms that opted to redeem and those that didn’t. The question: Which ones prepared better for the market shock in the months leading up to the Brexit vote and made the smarter calls in terms of opening or shutting their redemption gates?
Consider Edinburgh-based Standard Life Investments, which manages a $ 2.5 billion open-ended fund that invests in UK property. Standard Life chose to freeze redemptions partly to avoid having to go into the market and sell property at fire-sale prices, according to its executives.
A different approach was taken by Aberdeen Asset Management, which manages an open-ended fund that invests in UK property with assets of about £2.7 billion. Aberdeen temporarily froze redemptions in the aftermath of the June 23 vote, but lifted the freeze by mid-July after setting up new procedures for pricing redeemed units.
Aberdeen also has been able to resume redemptions by selling assets, including a commercial building on Oxford Street. Norwegian sovereign wealth fund manager Norges Bank Investment Management purchased it in mid-July for £124 million.
The Aberdeen fund was marketed to people, many of them small mom-and-pop investors, as an investment that they could buy and sell easily, said Russell Chaplin, chief investment officer of Aberdeen’s real estate team. “They have a reasonable expectation of liquidity in something that’s called a liquid fund,” he said, defending the firm’s decision to continue redemptions.
Experts say there are about 10 open-ended funds that invest in UK property with about £20 billion of assets. About half have halted redemptions. The other half haven’t.
These redemption decisions have got enormous attention following the Brexit vote because many expect UK real estate to be hurt by the country’s decision to exit from the EU. Demand for London office space and residences, for example, will likely weaken if businesses shift operations to continental Europe.
The different redemption strategies have clearly become a matter of pride and controversy for the firms. A spokesman for one of the managers, London-based Legal & General Group, said in an email that the firm “is one of the few firms not to close any of their property funds since the Brexit vote and they haven’t been making any fire-sale type disposals”.
He added: “They’re clearly better placed than the others.”
Many of those involved in the debate agree that it will take time to determine who was right. Halting redemptions likely will look smart if Brexit’s feared impact on UK real estate doesn’t materialise and prices rebound. But if values continue to fall, selling assets now will look like the right choice.
In any case, the industry’s response to Brexit is expected to be closely studied in the future by regulators and industry participants. A similar review, which took place after the 2008 global financial downturn in which many firms also froze redemptions, led to new regulations and disclosure practices, market participants say.
Open-ended funds have been popular with investors because they offered real estate returns without the volatility facing real estate companies with listed shares. They based their pricing of units on monthly appraisals of the property they owned.
Over the past 10 years, these funds have outperformed listed real estate stocks, according to John Lutzius, a managing director of Green Street Advisors. They have produced better returns partly because they charged investors relatively low fees and they have kept borrowing low, he said.
But the funds also have suffered from a structural flaw, Lutzius said. “They are making a promise of daily liquidity for assets that are inherently not liquid,” he said.
Some of the funds have dealt with this issue by increasing the amount of the fund that is in cash by selling assets when more redemptions are expected. For example, Aberdeen had increased its cash position to more than 20% of its value in the months leading up to the Brexit vote because the firm felt that the market had hit its peak.
Normally, cash makes up about 15% of the fund. “You never know when these things are going to come,” Chaplin said. “But you know at some point, if things are slow, people are going to want to have their cash.”
But increasing cash isn’t enough of a precaution when investors rush for the door following a market shock like Brexit. Aberdeen also is dealing with this through “antidilution” measures that apply an extra cost to investors who want to redeem quickly, Chaplin said.
“It’s no different to selling your house,” he said. “If you wanted to sell it tomorrow, you probably wouldn’t get what you were told it’s value was” by a real estate agent.
This story was first published by The Wall Street Journal