Steer clear of open-ended property funds

Investors should learn a lesson from the fund suspensions in the wake of the EU referendum

The Financial Conduct Authority, the City regulator, has asked open-ended property funds to provide daily updateson the health of their portfolios, sayJudith Evans and Kate Beioley in the Financial Times. Investors continue topull their money out of the sector.

In the last three months of 2018, investors withdrew a net £336m from British funds that own property directly, according to figures from trade body the Investment Association. Of this, £228m was taken out during December.

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Increased scrutiny by the regulator is not too much of a surprise. After the EU referendum in 2016, several open-ended property funds were forced to suspend trading to stem the flow of redemptions from people worried about the state of the market. Many of these funds imposed a "fair-value adjustment", essentially marking down the value of their properties (for example, Legal & General put in place a 15% discount, and Kames 10%). In total, around £35bn of money was temporarily locked away, though most funds were able to resume trading by the end of the year.

Investors stick with open-ended funds

Despite this, open-ended funds remain popular with investors. An open-ended fund is so called because it creates new shares for people who want to buy in, and buys shares back from people wanting to sell. When you buy a share in an open-ended fund, the price you pay directly reflects the value of its portfolio. So in the case of a property fund, you are paying for a share in the portfolio of property assets.

Open-ended funds are a viable way of owning assets, but in general they're not suited to illiquid assets such as property. Clearly it is harder and more time-consuming to sell a shopping centre than a share or a bond. If you get a situation such as 2016, when lots of investors unexpectedly want to sell their holdings, managers are forced to run through their cash reserves in order to meet redemptions. Once this runs out, they may have to sell properties in a hurry, meaning they could get less than the properties are worth, hurting remaining investors, who may then decide to sell out. It is to prevent situations like this that funds will suspend trading.

If you're looking to own property through a fund, you'd be better off looking at an investment trust. With trusts, you buy a share in an investment company that buys property, rather than in the property portfolio.You might not get the price you wantwhen you sell out, but at least you retain that option. F&C Commercial Property (LSE: FCPT) and Standard Life Investments Property Income Trust (LSE: SLI) aretwo popular UK property trusts, whilethe iShares UK Property UCITS ETF(LSE: IUKP) invests in a range of UKreal-estate investment trusts (Reits).

It's also worth noting that over ten years, property trusts have seen a net asset value return of 7%, relative to 4.3% for the equivalent open-ended fund, says Citywire.As well as requesting regular updates from open-ended funds, the FCA has proposed requiring that these funds halt trading as soon as the value of 20% of their portfolios is "uncertain", and stipulating firms put warning labels on funds of this type. Yet the regulator's review of open-ended funds is "a joke", Richard Shepherd-Cross of Custodian REIT told Citywire: "investors should not need protecting from a flawed structure".