“Property funds in turmoil” screams the Guardian headline today. This is nonsense. Here is some perspective.
First some high level observations.
After the Brexit vote stock markets fell sharply but quickly regained their poise. The FTSE 100 index is now at a high for the year. Nonetheless the more domestically focussed indices (the FTSE 250 and FTSE Small Cap) remain down 6% and 9% respectively for the year. The latter should be what we expect as a period of uncertainty works off – this is primarily uncertainty around politics which will resolve itself within a few months.
As we anticipated in an earlier note, the Chancellor has already talked about corporation tax rates being cut sharply. We would like to see rates for smaller companies cut to 10% – this is the sector that creates the most jobs. The Bank of England yesterday made clear its support for the economy – we will likely see more action in coming months, including lower interest rates and unconventional action e.g. buying corporate bonds.
The bottom line is that the authorities have all the tools needed to get through this period.
Standard Life get the ball rolling
In 2007/8 some companies like Standard Life, and other large insurers, suspended dealing in their property funds – Standard Life were first to move this time, followed by Aviva. But fund groups more focused on retail investors simply made price adjustments in 2007/8 and never suspended trading e.g. Henderson, M&G, and New Star. Funds such as these had significant cash buffers, and these held up well in 2007/8.
Where we are now is nothing like 2007/8. Back then property prices had been inflated by too much debt and speculation. Those two features are largely absent now.
Overseas buyers have been key to prices going up in recent years, in commercial and residential sectors. The greatest impact of this demand has been in central London, and prices there have not looked great value for some time (which is why we have focussed on funds emphasising the rest of the country, such as Kames and Threadneedle). In fact overseas buyers have been lukewarm on UK property since before Christmas.
Why fund suspensions now?
We are seeing no selling by clients and believe most of the selling which has occurred is by institutional investors and similar who are a bit panicky about the political outlook – this will pass in the months ahead.
These sorts of investors panicked into selling some property funds in February when the stock market fell. And when one or two sold since the Brexit vote, others have herded, and also tried selling.
In doing so some have accepted an effective penalty for selling of 11% – this is madness, and the instinct to herd overcame a more cool-headed analysis.
What happened to the cash buffers?
The action of Standard Life and Aviva was predictable taking into account the 2007/8 precedent.
The suspension by M&G was less predictable – unless you had been monitoring their cash buffer.
The Kames fund has more than 20% in cash, and Threadneedle 15%, which is sufficient to deal with sales when some investors get twitchy. Legal and General, a similar fund, has just issued a note confirming that they hold more than 20% in cash or similar liquid assets, and that it is business as usual.
In contrast the M&G fund had somewhat less cash before the Brexit vote – only between 5% and 7%, depending on who you ask. Our sense is that this cash has been largely depleted in the last fortnight, so they had no choice but to suspend dealing. Why?
Is it fair to suspend dealing?
Yes. Big institutional investors know that property is an illiquid asset i.e. it cannot be sold in a day. They also know that holding property is not a short term investment play. So if a number of them are daft enough to try and sell to cover a short term political risk, so be it, they’ll take an 11% hit.
If the fund groups, such as M&G, tried to meet those sales, with little cash in the bank, they would be forced to sell underlying properties in a fire sale, that is at depressed prices for a quick turnaround. This is all the more difficult now, because few are prepared to buy commercial property, except at sharply lower prices, until the political fog clears.
If fund managers were to make such property sales this would be grossly unfair on the loyal, more cool headed, investors, who remain in the fund – it would mean those that left got a better deal than those remaining in the fund.
It is to ensure such fairness that the managers of property funds apply these temporary suspensions.
Continuing confusion – what is “property”?
We have regularly aired this one, in the TopFunds Guide and elsewhere.
The funds we are considering here are first and foremost invested into bricks and mortar commercial property, with tenants, often household names, paying rent. Everyone went to work today, the rent is still being paid.
This is a completely different animal to a property company, which might build, develop or manage property. It is these companies that have been under pressure for some months, as can be seen in the share prices of property companies. Overseas demand for new commercial property has cooled, so the CEOs of such property companies currently do not have the confidence to spend tens of millions on a new development which might take 2-3 years to come to fruition.
Unfortunately press and TV comment (including the presentation by the Bank of England and FCA yesterday) do not make these distinctions, which is very unhelpful.
Head for the hills or…
If you were to buy a property fund today you buy it cheaper than a month ago, and with a higher income, with no reason to expect that income to fall – yields are in excess of 4%. That is very attractive in a low income world.
From the perspective of an overseas investor in UK commercial property, not only are prices a touch cheaper, but they are quite a bit cheaper due to the weaker pound.
In a very low income world this makes UK commercial property very attractive
And because property companies have slowed the building of new property, renewed demand will not be matched by new supply, which will help capital values move higher.
UK attractions and overseas risks
The UKs stable legal and political systems have been an attraction to global investors. The latter will soon be back in place.
In fact as political stability is re-established, and we move beyond a short term slow down in the economy driven by politics, the economy will again be driven by a mix of domestic strengths and global developments.
Some will dwell on the two year negotiations on trade with the EU (only accounting for 6% of GDP). Our view is that this feature is somewhat less important than scope for positive domestic government action (as we predicted there is already talk of much lower corporation tax) and negative global events (US slow down, China debt, Italian banks concerns etc).
Ironically the latter global risks serve to make UK property even more relatively attractive in a post-Brexit, “Theresa’ll fix it” world.
It would be churlish to ignore that we are living through a period of uncertainty in the UK.
But there is no need for investors to panic, or make ill advised sales at depressed prices.
The attractions of UK commercial property, particularly outside central London, remain very clear in a low income world – that was the case a month ago, and remains the case. This is so both for UK investors and overseas investors, for whom prices are even cheaper due to the fall in sterling.