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Troubled UK property funds see outflows ease as election result calms investors

Investors in open-ended U.K. property funds, which allow day-to-day investments and withdrawals, appear to have been reassured by the Dec. 12 election of a majority Conservative government as net outflows from the funds have since eased considerably.

In the three working days prior to the confirmation that the Conservative Party had won a healthy parliamentary majority, net outflows from U.K. property funds amounted to almost £75 million, according to data from Calastone Ltd, which monitors the funds' performance. The three working days following the result's announcement saw net outflows of about £23 million. The stemming of losses follows 14 consecutive months of net outflows from U.K. open-ended property funds, Calastone said.

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The surge in withdrawals ahead of the election followed the third-worst month of 2019 for outflows from the funds, when in November more than £250 million was withdrawn by investors, Calastone data showed. The weight of outflows prompted the suspension of M&G Real Estate U.K. Property Portfolio fund Dec. 4. In the two days following the suspension of M&G's fund, investors withdrew almost £100 million from other U.K. open-ended property funds, Calastone data showed.

"It's been less awful since the election," Edward Glyn, managing director and head of global markets at Calastone, said in an interview. "Although we continue to see outflows in the days after the election, it is a lot less marked than in previous days."

The election result has provided investors with greater certainty on the U.K.'s future relationship with the European Union, which has been unresolved since the country voted to leave the EU in 2016. The vote also ended the prospect of a Labour government, which promised to implement a raft of socialist policies seen as less friendly to business and investors.

While net outflows in U.K. property funds eased in response to the re-election of the Boris Johnson-led Conservative government, their performance paled in comparison to other U.K. equity funds, Calastone data showed. More than £138 million poured into non-real estate U.K. equity funds Dec. 13, the day the election result was announced, the data showed. This was the largest single-day inflow recorded in 2019, Glyn said.

Investors 'piling back in'

"Investors seem to have come off the sidelines and are now piling money back into U.K. equities, which many of us think have been somewhat undervalued for quite a long time anyway," he added.

Investors' unwillingness to show similar faith in U.K. property funds in response to the election result may be due to a number of factors. The suspensions of both the M&G fund and Woodford Investment Management Ltd.'s Equity Income fund in recent months have raised doubts among investors about the security of open-ended structures generally, but particularly for property, which is a highly illiquid asset, Duncan Scorey, director, private capital and fixed income at investment adviser Capital Generation Partners LLP, said.

"It seems to be a model that will work most of the time, but it has some structural weaknesses," said Scorey. "When you get a moment of stress, the problems can pile up pretty quickly."

The M&G and Woodford suspensions in 2019 came three years after seven of the U.K.'s largest open-ended property funds suspended trading in the aftermath of the 2016 Brexit referendum. The Financial Conduct Authority moved to tighten the rules around the suspension of U.K. open-ended funds earlier this year. Some industry bodies have criticized the FCA's response as too weak.

The weight of retail property held by many of the U.K.'s open-ended property funds is likely another source for some investors' concern, Scorey said. The growing penetration of e-commerce particularly has plunged the U.K. retail sector into a prolonged period of turbulence, with retailer insolvencies leading to widespread store closures, slashed rents and collapsing property values. M&G cited in a statement announcing the suspension of its fund "ongoing structural shifts in the U.K. retail sector [that] have made it difficult for [it] to sell commercial property," along with Brexit-related uncertainty.

'Bad news'

"If you look at the last six to 12 months, there has been a steady stream of bad news coming from the retail sector, with various medium and large retailers failing. And I think that's gradually sort of worn people down and made people incrementally more careful," said Scorey.

Retail property accounted for 33.7% of M&G's U.K. Property Portfolio fund's total value, minus cash holdings. Of the 11 other U.K. open-ended property funds that invest in retail property, and for which a breakdown of their portfolio is available, four hold retail property that accounts for 30% or more of their entire portfolio value, minus cash. One fund, Aberdeen U.K. Property, holds retail assets that account for 47% of its total value, minus cash.

Open-ended fund structures tend to attract smaller retail investors who may not have the expertise and knowledge to properly assess the performance of the retail property held by these funds, said Scorey. "Not all retail is bad," he said. "A few bad stories in the press could be enough to whip up worry pretty quickly, and it becomes a bit of a self-fulfilling process whereby a very manageable outflow gets amplified."