U.K. Property Fund Suspensions Send a Warning to the Junk Bond World
Investors in U.K. commercial real estate just touched a nerve.
In pulling their money out of property funds at such a rapid pace four asset managers froze withdrawals this week, the investors showed how the cost of Brexit is spreading. They also tapped into one of the biggest fears of bond market observers: a mismatch between the liquidity of investment funds and their assets.
The real estate funds are designed to allow investors to withdraw their money on a daily basis, while the properties backing them could take months to sell. That's similar to many mutual and exchange-traded funds that buy junk bonds — securities that can take weeks to sell — and offer daily redemptions.
Yet while the property funds have grabbed the headlines and spooked markets, the bigger threat may be posed by bond funds.
Only about 7 percent of the total commercial real estate market is held in daily-dealing funds, according to the Bank of England. Meanwhile more than 90 percent of all European corporate debt funds, including high-yield bonds, offer daily redemptions, according to Fitch Ratings.
The credit markets had a recent taste for how a liquidity mismatch might play out when in December Third Avenue Management froze withdrawals from a $788 million credit mutual fund, saying it couldn't meet redemptions without resorting to fire sales. The move triggered a selloff in high-yield bonds and stock markets and prompted other funds to close.
And the issue is still a live one. The Financial Stability Board, whose members include the U.S. Federal Reserve and the Bank of England, said on June 22 that exchange-traded, mutual, and other funds deserve extra oversight to ensure they can sell assets to meet investors’ demands to pull out their money during volatile markets. The growth of the $76 trillion industry and the funds’ move into more complex assets have drawn regulators’ attention, the FSB said.
Meanwhile the European Central Bank said on June 27 that daily-dealing funds can add to the illusion of liquidity and cause instability:
By offering daily callable claims for investing in less liquid instruments, open-end funds may further add to the illusion of liquidity if investors do not properly discount for the liquidity transformation risk. Industry-wide competition on the part of asset management firms may lead to a race towards the open-end form, where the promise of daily liquidity is used as a positive signal for attracting inflows and a suboptimal level of liquidity transformation in the financial system as a result.
For all the fear about real estate funds, it's worth noting that the funds in question, run by Henderson Global Investors, M&G Investments, Aviva Investors and Standard Life, are all invested in prime properties. An office building on Curzon Street, the home of Moore Capital Management LLC and Man GLG, as well a property in London's Soho Square compare favorably to bonds from lowly-rated energy companies facing lower oil prices and weaker commodity demand.