The problem with open-ended property funds is that the liquidity required by regulators is incompatible with investing in real assets – how can we resolve this?

When it comes to investing, the illiquid nature of real estate is its defining characteristic relative to investing in equities or bonds. This illiquidity is the prime explanatory factor for the risk premium over the risk-free rate of investment and gives property investors the returns profile and diversification benefits they seek, assuming they are investing for the long term. An asset class with round-trip costs (to buy and sell) of 8.5% and an average hold period (for institutional grade assets) of 5.5 years is not a natural fit for a fund structure that is required, by Financial Conduct Authority prescription, to provide daily pricing and be daily tradable. Open-ended property fund structures that deal in inherently illiquid assets should be seen for what they are – or rather what they are not, which is fit for purpose.

The recent consultation announced by the FCA on proposals to introduce redemption notice periods of at least 90 days and potentially up to 180 days is another half-baked measure in an attempt to resolve the long-recognised failing of open-ended funds investing in inherently illiquid assets, that of the liquidity mismatch. The Woodford Investment Management fiasco last year and the closing to redemptions of the open-ended property funds again this year (this time due to ‘material value uncertainty’) have brought this issue back onto the regulator’s radar.

Property fund managers trying to pool long-term institutional capital with short-term retail capital (and its contingent regulatory constraints) through the accumulation of real estate has become a modern-day Gordian knot, impossible to resolve. The increasing popularity of the platform investors that pool retail investor capital into ever larger flows into and out of asset classes on a whim, according to their models, has exacerbated this problem.