Property - uncertainty, illiquidity and the return of swing pricing

28 JANUARY 2019

City Asset Management favour direct commercial property as an asset class. However, there are two ways of accessing property exposure through funds – open-ended vehicles and closed-ended vehicles (i.e. investment trusts). We tend to favour the latter due to the constant liquidity of this investment vehicle.

One of the reasons we do not have property exposure in open-ended vehicles is due to a characteristic referred to as “swing pricing”. Essentially the price of an open-ended property investment vehicle reflects the net asset value (NAV) of the underlying property and cash held in the fund at any one time. In times of uncertain economic conditions, property prices can come under pressure. Historically, during these periods, investors try to quickly withdraw their money.  The issue arises when fund managers who run these open-ended property funds do not have the capital (i.e. cash) to quickly meet the demand for large amounts of withdrawals and are not able to promptly liquidate assets (properties). Typically, even a quick sale of a property can take several weeks.

When demand for net outflows from a fund exceeds a preestablished threshold and in order to prevent fund managers having to panic sell all their property assets at large discounts, the fund managers can ‘swing’ the price to reflect the cost of transacting in property. This is usually a 5-6% cost, which is replicated in the price reduction. This protects the unit holders’ net holding in the fund from transactional costs, essentially lowering the NAV and hence share price.

This means that the fund managers have to pay out less to those wanting to withdraw investments and, importantly, the price move disincentivises investors from withdrawing capital.

In the wake of Brexit, we experienced a high number of open-ended investment vehicles using this technique. As well as swing pricing, it is not uncommon for open-ended vehicles to use another method of preventing investors withdrawing capital, namely ‘gating’. This is where funds limit or suspend redemptions completely, further increasing the illiquidity of the investment vehicle.

For these reasons we prefer to use investment trusts to gain our property exposure within portfolios. These closed-ended vehicles provide us with better liquidity, where holdings in investment trusts can be bought and sold on the market. The price of investment trusts will of course, fluctuate, moving between discounts or premiums to net asset value depending on buying or selling pressure. There is, however, always a market in the shares and these vehicles can never ‘gate’ or close to sellers. In the case of investment trusts, managers are not concerned about investor redemptions, meaning they can afford to be fully invested in property and hold less cash reserves than those managing open-ended vehicles. Therefore, by using investment trusts we can get more exposure to property and have potentially better liquidity if markets turn. 

It is true that open-ended vehicles can hold lower cash balances if they have the ability to use gating and swing pricing in times of uncertainty. However, with the use of investment trusts we do not have to worry about the consequences to us, the investor, of a fund manager employing these techniques.

As real return investors, we try to grow your wealth at an agreed margin above inflation. In times of uncertainty, we have the ability to be dynamic and, consequently, we do not want to have exposure to these open-ended property assets, which can restrict our ability to change asset allocations as circumstances change.

Alexandro Zaccarini

Investment Analyst

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