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Am I invested in UK Commercial Property Funds and should I worry?

The papers have been full of stories over the weekend on the demise of the M&G Property fund. The panic appears to be spreading within this sector. Indeed (according to BBC News) some £97 million in funds was withdrawn from property funds on just one trading platform over Thursday and Friday last week.

All of our Thomas and Thomas Proactive clients will recall that there was a flurry of activity within their portfolios in June of this year as we removed all exposure to UK property funds.

The textbook approach to investing for clients, is always to diversify between Equity, Fixed Interest and Property classes. In June I faced a real dilemma.  I have long believed in the diversification benefits of UK commercial property and had used it within client portfolios for the past two decades.  The steady rental yield and relatively boring nature of the asset class offers something we crave – negative correlation (diversification benefits).

There have been several historical occasions where property has offered positive returns when equity markets are falling. There are also other occasions where property has offered something of a safe haven when bonds are struggling.

Removing the whole asset class in its entirety six months ago seemed a very drastic step.  So why did we do it?

Our concern for UK commercial property was based on four key factors.

Liquidity

I have lived through two occasions where perfectly good property Funds have locked down or ‘suspended’. This was in the Great Financial Crisis of 2008 and post Brexit Referendum in 2016.  On both occasions, the suspension of a property fund within our client portfolios created mayhem when attempting to rebalance, encash funds, add monthly savings etc.  In both periods of history, it was the whole sector that got caught – so even some very well managed funds were temporarily locked down.

Sterling

It was reported that overseas investors had been attracted to buying UK property on the back of a cheap pound (Sterling). This has fuelled the market to an extent. Our concern at Thomas and Thomas was if Sterling should strengthen. What would stop foreign investors then cashing back out of this market to realise their gains? Sterling has recently strengthened.

Recession

With some sort of mild global recession indicated, we have to ask which investments are most vulnerable. Retail outlets are a sitting duck for recession. Whilst the property funds we used were not heavily exposed to retail outlets, we felt that systemic risk might not be easily avoided.

Performance Drag

Property funds require considerable management and usually have higher charges than equity and bond funds. Property funds have been forced to hold higher percentages of cash to meet the liquidity risk. We asked: ‘Is a fund that has high charges and high levels of cash receiving low interest a good solution?’.  Interestingly, the two property funds that we recommended leaving in June have grown by a combined amount of around +0.5% according to Financial Express Trust Net.  The combination of Equity and Bond funds that we recommended instead have currently returned around +3.5% over the same period according to the same analysts. Our ‘drag’ fears appear to have been vindicated in the short term at least.

Summary

UK Commercial Property has not suddenly become a terrible investment. I believe that it will have its place again within portfolios. However, it is currently facing a raft of challenges which we believe could create short term problems for client portfolios. This is why we recommended coming out.

At Thomas and Thomas we take the time and effort to carefully consider our clients funds. Our robust and repeatable investment process means that we are on the ball and once again we feel proud of our decision for our clients in light of last weeks’ breaking news.

As always, we are here for you 100% if there is anything that you are worried about – just let us know.

Best wishes

Darren

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