Commercial Property crash? Absol-EU-tly not!

07 July 2016

Since the EU Referendum, there has been much stock market volatility, and not only in the UK. This has now reached commercial property funds, with many of these contracting either in value or in the way that they allow access to capital or income. Good comment on the evolving situation can be found here from Cormorant Capital Strategies, which helps Chapters Financial Limited with its Investment Committee and views on investment diversification.

Obviously it is early days in the transition of the UK out of the European Union (if our politicians do finally decide to apply for Article 50…) and the notes below are a good example of why it is important to keep your investments under review.

This is a complex subject and if you would like to discuss or clarify any points then please do get in touch.

Cormorant Capital Strategies notes:

Imagine a world in which aggregate share prices can be driven forty or fifty percent lower, where high quality corporate bonds can lose a fifth of their value and where investment managers can refuse requests from investors to liquidate their assets. That is not the view of a landscape scarred by a sudden and unexpected political event. Rather, it is what we consider to be a routine appraisal of the risks attached to investment.

Harnessing, not hoping

We don't design investment portfolios with our collective fingers crossed, hoping that those risks never manifest. Instead, in prospecting for long-term gains, we aim to identify, assess and ultimately harness them.
Some aspects of risk can be mitigated. Our portfolios [the portfolios put together by Chapters Financial in conjunction with Cormorant Capital Strategies] are the product of a process intended to moderate the worst effects of asset price volatility and dysfunctional market conditions; equity risks are hedged where hedging is appropriate and unusually illiquid assets are matched with highly liquid assets. The principles we employ have been tested on numerous occasions. And they will be tested again, if not now, at some other time.

Harsh, harried movements

It has been said that, post Brexit, the market is remarkably calm. Indeed, if we take the Friday before the referendum vote as our starting point and today [05 July 2016] as our finish, the FTSE 100 index has gained 8.4%. Companies with significant overseas earnings, buoyed by a near 10% decline in the value of the pound, have seen surging share prices. Mining and tobacco sector stocks are up close to 20%.

But the market values of those with a domestic, rather than international, focus have taken a tumble. Banking stocks and Real Estate Investment Trusts (REITs) are down an average of 10%. Volatility in the dollar-value of the pound is at its highest level in four decades and the ten-year gilt yield, already low by historic standards, has fallen a further 0.5%. Combined, these movements form the bow wave of likely weaker economic conditions.

Battening the hatches

Today saw the publication of the Bank of England's twice-yearly Financial Stability Report. The Financial Policy Committee (FPC) identifies 'adjustments in commercial real estate markets' as one of five contemporaneous 'challenges to the outlook for financial stability'. That brings developments in the commercial property sector into sharp focus.

A month ago, we explained that recent swings in the pricing policy of several commercial property funds were in the interests of long-term investors – those, like us, intent on remaining invested. Commercial property is illiquid in the first instance and expensive to transact in the second instance. Those transaction costs should be borne by those leaving the fund, not those remaining in the fund.

More recently, the same group of commercial property funds have gone a step further and temporarily suspended trading. That means that orders to sell or to buy shares in those funds will be ignored for an unspecified period of time. We expect almost all 'bricks and mortar' property funds to impose similar restrictions. This is not the first time that a moratorium on share sales has been imposed.

Hardly hysterical

In fact, it is worth stressing that the suspensions we see commercial property fund managers applying are unlike other kinds of suspensions in share trading. In this instance, this is no panic measure. Suspensions are written into the design of the structure of these funds to ensure that shareholders are all treated equally fairly.

A happy bank

We suspect that news of multiple fund suspensions has been broadly welcomed by the Bank of England.
The FPC is concerned that weakness in the commercial property sector 'could reduce companies' access to finance, amplifying shocks to the real economy'. Around three-quarters of the small- and medium-sized companies that borrow capital from banks do so using commercially-owned property as collateral for those loans. The Bank of England is keen to see lending volumes maintained, so it has an interest in limiting the potential for reduced values. And with open-ended commercial property funds accounting for around 7% of the UK market, any stresses that do become apparent would otherwise be exacerbated by redemptions.

Proceed, how

If you're taking regular income withdrawals through unit encashment or automatically re-balancing a portfolio, the suspension on share sales will upset that process but there are easily worked solutions. Here are one or two suggestions…
To rebalance, simply exclude commercial property from the exercise; the balance between equity and fixed income is the more important ratio. In the case of income provision, make up for any shortfall by first targeting overweight portfolio positions. Beyond that, the low level of liquidity that characterises commercial property investment is mirrored by the high levels of liquidity afforded by gilts – particularly short-dated gilts. That is why they are there. Use them.

We hope that these notes provide a balanced view of the evolving landscape for commercial property investments. As always with our blogs, no individual advice is provided during the course of this blog. If you would like to review your pensions, savings and investment arrangements then please contact the team at either our Guildford or Woking offices.

Keith Churchouse FPFS
Director
Chartered Financial Planner
CFP Chartered FCSI
ISO22222 Certified

Chapters Financial Limited is authorised and regulated by the Financial Conduct Authority, number 402899.

Important information

While a reasonable course of action regarding investments may be formulated from the application of our research, at no time will specific recommendations or customised advice be given, and at no time may a reader be justified in inferring that any such advice is intended. Although the information contained in this document is expressed in good faith, it is not guaranteed. Cormorant Capital Strategies Limited will not accept liability for any errors or loss arising from the use of this document. Readers are directed to our terms and conditions. Crown copyright material is reproduced with the permission of the Controller Office of Public Sector Information (OPSI). Bank of England data reproduced with kind permission of the Bank of England. Cormorant Capital Strategies Limited is registered in England number 05346579. Our registered address is 84 Bromefield, Stanmore, HA7 1AQ. Our VAT registration number is 159 5632 77. Visit our website at www.cormorantcapitalstrategies.com.