UK property funds moving to a bid basis is not all that shocking. The worry is whether this creates panic among investors, forcing funds to sell assets and suspend dealing.
This is not unprecedented. Henderson had a prime residential property fund in the late 1980s that was shut for some seven years, with investors only able to get out of the fund every six months.
Norwich Union’s £4.4bn property trust and New Star’s £2bn property fund moved to a bid basis on July 9. This shows there were more sellers than buyers into the fund. It does not, however, mean that there were sellers every day or that redemptions were even that high.
Morley head of product development Jeremy Soutter says such is the size of the Norwich property trust and its liquidity that it could be kept on a bid basis for years before the managers were forced to sell property to meet redemptions. Being on a bid basis for that long, though, is highly unlikely.
He points out that over the recent weeks in which the fund has been on a bid basis, there have been some days when there were more buyers than sellers. The fund remains on a bid basis because the managers feel that in the medium term, on average, there will be more sellers than buyers. Until there is greater certainty to the contrary, the fund will remain at the lower price.
Spurring sales have been recent falls in fund returns, some of which Soutter attributes to falls in property shares, which brick and mortar portfolios hold for liquidity reasons.
It is worth keeping in mind that there is an advantage to property funds being at the lower price. It means that those buying into such unit trusts at the moment are getting the funds at a significant discount – something that rarely happens with open-ended funds. Property funds that invest in bricks and mortar are by and large unit trusts and, therefore, dual priced. In fact, there is only one retail bricks and mortar fund in an Oeic structure – New Star’s international property fund – and even that opted to be dual priced.
The spread between the two prices – bid and offer – tends to be around 5 to 7 per cent and is said to be there to help cover the costs of stamp duty as well as the other costs associated with acquisitions and sales. This spread is not static and consists of three points – the cost of cancelling the units (say 94p), the cost of creating units (say 100p) and then charges, including initial charge (say 105p). The spread moves between these three points, which are set around the net asset value of the property held within the fund.
Investors buy at the offer price and sell at the bid price. When a fund has more buyers than sellers, the price of the units is at the higher level, the cost of creating the units and the charges on top of this. When a fund is on full offer, managers generally place the bid price some 0.5 per cent lower – quite a bit higher than the cost of cancelling the units.
When there are more sellers, the price scale is centred at the cancellation point and the fund is said to be on a bid basis. Leavers in a fund priced this way sell their units at the cancellation price (94p) while buyers come in around 0.5 per cent higher – 5 per cent lower than if the fund was on an offer basis. If investors bought a fund today that was on a bid basis and the fund moved to an offer basis tomorrow, they could see a 5 per cent uplift.
There is no denying the interest created by property funds being on a bid basis. It has been 12 years since a fund like Norwich property trust was priced at that level. The story at this point is not bleak. The real danger is what this negative attitude and fear could create.
Soutter says all UK funds that fall under the FSA’s Coll rules – be they unit trusts or Oeics – can suspend dealing for rolling 28 days. This is to try and avoid a situation that would create a run on assets and force the managers to sell, which would impact on the overall value of the fund. Forced selling could in turn create a crash in the commercial property market.
The trigger point for a fund suspension will be when a fund runs out of liquidity to meet redemptions. In the past, rules concerning bricks and mortar property funds required managers to have minimum 20 per cent liquidity to accommodate redemptions. Recent rule changes have led some bricks and mortar funds to switch to a non-Ucits retail basis, under which the fund can have 100 per cent in what are termed immovables – in other words, they do not need to have that 20 per cent redemption buffer.
Funds being switched to a bid basis is only half the story. More attention should be paid to what is happening in the market and potential impact that panic selling could create. It is already easy to see the knock-on effect of funds switching to a bid basis. All have had to move to this pricing. The danger in the market is what happens if just one fund suspends dealing on the back of these redemptions?
A fund with a high property element suffering large redemptions could be the catalyst for a run on property. This scenario is unlikely in a big property fund with high liquidity but small, highly concentrated property portfolios may be more vulnerable to such an event. The problem is the suspension of even the smallest fund in the market could create enough panic, even if unwarranted, and the knock-on impact could affect the sector as a whole.