The UK’s largest property fund was gated in March, when the coronavirus pandemic forced a wave of bricks-and-mortar fund suspensions due to ‘material uncertainty’ over the valuation of UK property.
At the time, the fund managed £2.9bn in assets and held 22% in cash, which by the end of December had dropped to 14%.
Speaking to Citywire, the fund’s co-manager Matt Jarvis (pictured) said the flows have now moderated and a number of clients have even reinvested in the strategy.
‘Towards the end [of the period] we spent a lot of time engaging with our investors and consulting with them what their intentions were after we reopened,’ he said.
‘That allowed us to form a plan, raise cash and undertake further sales to make sure we could meet redemptions […] We had a view as to what the redemptions would be and what we’ve seen has been in that range so we’re happy in that sense.’
L&G UK Property is not the only real estate-focused fund to suffer redemptions. In 2020, property funds saw £1.1bn in outflows according to global funds network Calastone.
The sector is also facing tough regulatory scrutiny, as the the Financial Conduct Authority (FCA) is trying to impose stricter rules on open-ended funds holding illiquid assets, including a six-month notice period before clients can pull their cash.
But despite these challenges, Jarvis believes better times are ahead and property still has a lot to offer investors.
‘We’ve seen property market values correct; the fund has had a great year relative to the market. We are in a position where we have the right dynamics in the fund, sectors and stock selection,’ he said.
In 2020, the fund returned -1% versus the sector’s -3.7% average. Over three years to the end of December, it has delivered 6.9% compared to 0.6%.
Negotiations with tenants
During the months the fund was closed to trading, the managers made sure they were communicating with both tenants and their investors on an ongoing basis. Some tenants, particularly those in retail and leisure sectors, were hard hit by the lockdowns.
‘We worked on a case-by-case basis. Where we felt they had appropriate business plans to get through we were prepared to offer some relaxation on how they paid their rent.
‘It’s been successful and allowed our tenants to get through that difficult cash-flow period and in some instances unlocked some value for us,’ Jarvis explained.
High street retail and leisure make up only a small part of the fund’s portfolio at 3.7% and 3% respectively. The bulk of the allocation is to industrial real estate, with 38.4%, followed by regional offices, with 21.1%.
Although many offices have been left empty because of measures encouraging working from home, Jarvis said the fund was able to still collect the rent from its tenants.
However, he pointed out that there are structural issues and short-term questions on how to get the office market working again, which has resulted in a short-term loss of sentiments.
‘It is widely expected to recover,’ he added. ‘I personally think the short-term loss in sentiment is just that – short-term. When businesses are able to map out how they can bring their occupiers back, part of that solution will include a drive towards better quality office space and sustainability credentials.’
He said the fund has been reducing a little bit of its office exposure to adjust for the medium term.
In addition to the industrial sector, the fund is also overweight in what Jarvis calls ‘alternatives’, which refers to anything that’s not an office, retail store or industrial asset. While this includes healthcare assets, hospitals, car showrooms and even self-storage, Jarvis is most excited about the emerging build-to-rent residential market.
‘Within build-to-rent we see particularly strong rental growth prospects. We are excited about a scheme being built in Chelmsford – our first built-to-rent residential holding.’
The asset, Chelmer Waterside, was acquired last February and is part a major mixed-use development in Chelmsford, comprising 421 residential apartments, associated landscaping and local retail amenities.
FCA scrutiny of open-ended property funds has many investors on edge, as they are waiting to see what the new rules around notice periods will be. Jarvis said that through the consultation period, the firm has had good engagement with the regulator.
And if the watchdog does introduce a 180-day notice period for redemptions for example, he believes there is still a lot that would need to be done before such a requirement can be implemented.
‘It would take some time and it would require development in the infrastructure. Over that period, it would be a case of investors understanding how it impacts them,’ he said.
In recognition of the gap in liquidity between the fund itself and its underlying holdings, the managers have also introduced a 4% allocation in the fund to real estate investment trusts.
This portion of the fund targets the more liquid UK real estate investment trusts, with a degree of stock selection to ensure that the allocation is made away from retail and towards alternatives and industrial assets. Over the course of 2020, this part of the portfolio has supplemented performance, Jarvis said.