The Willis Towers Watson strategic asset allocation model allocates 15% of portfolios into property.
We prefer to invest in direct property funds whose managers own and actively manage a diversified portfolio of UK commercial, industrial, office and retail property investments rather than fund managers that buy and sell shares in property companies.
The core UK property representations in our portfolios are Standard Life UK Real Estate and Legal & General UK Property funds.
Property provides diversification benefits as returns from direct property have low correlation to equities and bonds and can produce smoother longer term returns owing to returns generated from rental income. Property rental income can act as a hedge to inflation as commercial property leases in the UK are often arranged with automatic regular rent review increases. In addition direct ownership of property offers the potential for capital growth as property valuations generally increase over the longer term. Property fund managers can also add value by active management from development or modifying use to accommodate the demands of future tenants. Property should be considered a long term investment of at least 5 years.
Since May 2013 we have observed increased cash flows to UK property funds due to; improved investor confidence, attractive yield and inflation hedge characteristics of this asset class. Increased fund flows have become a concern as fund managers have been under pressure to deploy cash in an increasingly competitive UK property market. Our concern was such that in January 2014 the Gresham Wealth Management investment committee took the tactical decision to reduce property asset allocations with portfolios retaining 10% or 12.5% weighting. Overall, our recommended portfolios do not have large exposures to the Standard Life UK Real Estate and Legal & General UK property funds and we are generally underweight UK property as an asset class compared to other actively managed investment solutions.
Following the outcome of the EU referendum and increased uncertainty in valuations for the UK commercial property market, many UK property funds have announced changes to fund pricing and application of charges as measures to protect existing investors from being disadvantaged by the negative impact of large outflows. For existing investors the impact of Brexit has materialised with a downward price impact in the region of 15% across UK direct property funds.
Property funds often retain large cash balances to manage liquidity however if the fund receives increased redemption requests from investors the fund manager may be forced to sell properties when market valuations may be suppressed and do not necessarily reflect the true intrinsic value of the property. Transactions often take considerable time to complete and incur sizeable costs on the sale and purchase of commercial properties.
On 4 July 2016 Standard Life announced withdrawals would be suspended from the UK Real Estate fund. This restriction will be reviewed by Standard Life every 28 days on an ongoing basis. Subsequently other leading UK property fund management teams including Aviva, Henderson, M&G, and Threadneedle suspended trading in their property funds.
At time of writing, Legal & General has not suspended trading in the fund. This is subject to ongoing daily review. We do not recommend that investors should sell holdings in Legal & General UK property fund at this time.
For existing Gresham Wealth investors the implications are as follows:
- Since 23 June 2016 valuations in the Standard Life UK Real Estate fund and Legal & General have reduced by 5% and 10% respectively.
- For investors taking regular withdrawals or making regular contributions, investment instructions will be reviewed and changes made to ensure continuity of income payments and standing instructions for regular premiums are suitable. We will be contacting investors affected to recommended changes to existing investment instructions.
- Investment portfolio reviews will be impacted as property funds cannot participate in the rebalance.
It is with reluctance that we recommend that no further monies should be invested into UK property funds until liquidity issues have receded and the funds are fully tradeable / accessible. Consequently we recommend increased allocations to ‘cash’ as a short term (< 12 months) investment strategy. It should be noted that cash deposit rates are not attractive in the current low interest rate environment and retaining large cash balances for long periods should be avoided as higher anticipated inflation will significantly erode the real value of your investments over the medium to longer term.
We are confident in our belief that UK property funds and the managers we recommend will continue to deliver attractive returns for longer term investors.
For further advice please do not hesitate to contact us and speak to one of our chartered financial advisers.