Property funds look like an attractive way to profit from real estate. But the post Brexit slump reveals the advantages of bricks & mortar.
In the aftermath of Brexit, open ended property funds offered by Henderson Global Investors, Columbia Threadneedle, Canada Life, Standard Life, Aviva, and M&G have suspended trading. So what are these funds, and why have other funds not been similarly affected?
Two Kinds of Investment Fund
Let's start with some definitions. There are two kinds of investment fund:
An open-ended fund is one in which there is no limit to the number of shares that can be issued. Shares in open-ended funds are not traded on an exchange, and their value is calculated based on the value of the assets held by the fund. Purchasing shares creates new ones, while shares that are sold are taken out of circulation.
A closed-end fund is one in which a fixed number of shares are issued when the fund is launched. These shares are then traded on an exchange.
Open & Closed Ended Funds – The Differences
In order for shares in an open-ended fund to be bought and sold, the fund must have sufficient cash to cover these transactions. This works under normal conditions or when the market is doing well. However, if circumstances arise in which a lot of investors decide to sell their shares, then the fund will have difficulty in paying up. This does not apply to closed-end funds since trading is done through an exchange.
Property funds use the pooled investments of shareholders to invest in property. They are a way for people to invest in property without owning it directly. This arrangement also allows investors to buy and sell a range of property--such as a mixture of commercial and residential--through the fund.
The Post-Brexit Shift
After the Brexit referendum, investors moved away from domestic UK businesses towards international companies. UK property funds were badly hit by this situation: a shopping mall in Britain is about as domestic as any investment can get. As investors lost confidence and tried to redeem their shares, the cash reserves in these open-ended funds started running low.
The Risk Of Suspended Trading
Of course, the way to raise more cash would ideally be to sell off some assets. However, unlike equities, it takes time to sell property: the building has to be put on the market, a buyer has to be found, a deal negotiated, and the legal business concluded. At some point, as the cash starts running out, property funds have no choice but to suspend trading, which is exactly what happened to Standard Life, Aviva, and M&G.
This sort of thing has happened in the past with open-ended property funds, in fact as recently as the financial crisis of 2007 – 2008. But it seems that investors may have short memories. It’s also unclear whether or not investors in these funds were fully aware of the risks. Financial advisors say that there are no hard and fast rules on warning investors about the possibility of suspended trading.
Good Prospects For Real Property
Despite these events, long term prospects for the UK property market are still good. Real, physical property remains an attractive investment at a time of low interest rates, and the reduced value of the pound makes UK property attractive to overseas investors.
In fact, this looks like a very good time to invest in both residential and commercial property, particularly as a long term investment. There is also the possibility of another cut in interest rates, which will make investments even more profitable, so investing in property directly makes good sense, and avoids the pitfalls of property funds.
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