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Ian Cowie: Brexit and the barmy army of open-ended property funds

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Ian Cowie: Brexit and the barmy army of open-ended property funds

Brexit has already provided one brutal demonstration of a fundamental advantage of closed-end funds over open-ended rivals and I suspect there will be more to come – but have City regulators noticed?

The reason I ask is that the Financial Conduct Authority (FCA) is consulting on how pooled funds can cope with investments in illiquid assets such as commercial property. About time too, after six open-ended funds failed to live up to their name last year by imposing penalties on investors who ran for the exit after the Brexit referendum – or simply suspended dealing altogether.

Despite these unit trusts’ failure to cope with outflows – and similar setbacks I can remember at New Star and Target property funds stretching back to the 1980s – the FCA has already said it will not ban open-ended funds from investing in illiquid assets, such as office blocks and shopping malls which are inherently difficult to turn into cash in a hurry.

Now new research from the Association of Investment Companies based on independent statistics from Morningstar shows how closed-end funds have consistently beaten open-ended rivals in this sector. Commercial property investment trusts delivered an average of nearly six times more than unit trusts over the last decade – 60% compared to 11%.

The difference was even more marked over the short term, with 10 investment trusts in this sector delivering an average of nearly 13% total returns over the last 12 months, compared to losses of 0.46% among two dozen comparable unit trusts in the year to May 11. Commercial property investment trusts also beat their unit trust rivals over the last three and five-year periods.

The explanation is that closed-end funds do not have to sell their underlying assets – such as office blocks – when weak holders clamour for cash; instead, they can let the share price take the strain. As a result, long-term investors’ returns are not eroded by the cost of providing liquidity at any price – including ‘fire sale’ valuations – to short-term speculators.

Interestingly, investment trusts also offer better value to income-seekers with an average yield in this sector of 5.3% compared to 3.4% from commercial property unit trusts. The reason is that open-ended commercial property funds sometimes hold up to 30% of their assets in cash to cope with potential redemptions.

Despite this damning analysis, only the most naïve reader will be surprised to learn that four times more money is invested in the type of pooled fund which has consistently underperformed over the short, medium and long term both in terms of capital growth and income. Commercial property unit trusts hold £17.4 billion compared to £4.3 billion in investment trusts.

When is the FCA going to do something about the bias shown by many advisers and other intermediaries which so consistently causes consumer detriment to savers and investors?

With even the prime minister predicting ‘bumps in the road’ before Brexit becomes commercial reality, it would be nice to believe the FCA will act before the next property crash. Sad to say, while past performance is not necessarily a guide to the future, that would not be the way to bet.

Full disclosure: here is a complete list of Ian Cowie’s stock market investments. It is not financial advice nor is any recommendation implied.

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