St James’s Place (SJP) has been under fire recently and we have had a few calls regarding the property fund being suspended. It is not unlike most property funds where liquidity is the issue, so from here on, I will just talk about property funds per se.
A property fund is included in your portfolio/pension/ISA because it generally negatively correlates with equities. Negative correlation means that when an equity is under pressure, property may rebound and vice versa.
Property also has a lower standard deviation than equities. Standard deviation measures volatility and risk, showing how much a fund’s returns can deviate on a month-by-month basis in comparison to the average.
The MSCI UK Quarterly Property Index reported a standard deviation of between six per cent to 10% over recent years. The S&P 500 Index contrast shows a standard deviation of 15-25%, more than double the risk.
There are many ways to assess risk of course, and standard deviation is just one. Measuring risk by just standard deviation will have you caught very short. Standard deviation is a quantitative risk (numbers), but there are qualitative (thinking) measures to assess risk too.
Because property has less liquidity, it is traded less and that leads to lower volatility and fluctuations. Equities are subject to so many market sensitivities, macroeconomics, company performance and sentiment, they can fluctuate wildly. Furthermore, property offers the joy of stable income and that stability smooths out returns.
However, there are qualitative risks. With an open-ended fund like SJP’s there can be liquidity mismatches. When investors decide they want cash quickly, through a panic perhaps, the fund won’t have enough cash aside to deal with that and then they have to sell assets - assets that are as liquid as Donald Trump’s six failed bankrupt hotels between 1991 and 2009.
If a fund doesn’t have the cash, it looks to other liquid assets like easily sellable properties, and if they aren’t available this creates a tailspin. During Brexit, or the recent health pandemic, there were surges in withdrawal requests. In such a panic, the fund managers have two choices - sell down assets or gate the fund to stop withdrawals.
It’s hard to have your cake and eat it. If you want low standard deviation, you can’t be allowed willy-nilly access as the fund would become too volatile, so they gate the fund.
If they were to sell down assets to pay out to customers, it’s blatantly obvious to all buyers why they will be doing it, as its publicly quoted, so sitting there watching a price plummet would seem a good strategy if you are a buyer. Meanwhile the seller, and in turn you the investor, loses out.
Furthermore, Real Estate Investment Trusts (REIT) can gear (borrow money) and buy up all these distressed assets easily and at a discount. This is not an option for open ended funds like SJP’s. If, and when, the market returns, those REITs could sell the properties back at a premium.
As the above issues occur, they are often not understood properly, the investor reads the headline, not the detail, and hey presto, we have a run on assets.
It just doesn’t make sense to allow investors to gain speedy access when there are difficult times.
And so, the property funds have to take measures such as gating a fund which allows 10% of the fund per quarter to be sold off (will still create distressed assets); introducing notice periods before customers can withdraw funds (90 days) which allows further time to sell down assets.
Other measures the funds could take would be to have higher cash reserves to allow quicker cash access but that would mean less of your fund is invested, the performance would be lower, and customers wouldn’t invest due to its lack of attraction.
Of course, you don’t have these problems with closed ended fund structures like REITs but that is shares, and a different risk class, so consider both, but for different reasons.
- Peter McGahan is chief executive of independent financial adviser Worldwide Financial Planning, which is authorised and regulated by the Financial Conduct Authority. If you have a financial question for Peter, call 028 6863 2692.
