A lesson learnt the hard way

Posted on 13 July 2016 by Douglas Chadwick

Commercial Property funds such as M&G, Threadneedle, Kames, Aberdeen, and Standard Life have for the last few years been the stabilising feature of both of the Saltydog portfolios. They have been producing a very nice small regular monthly uplift and we have used these funds as an alternative to cash, with the safer Tugboat carrying a greater percentage than the more adventurous Ocean Liner. Up until the Brexit referendum all appeared to be smooth sailing, but then upon the announcement of a vote to leave all hell was let loose. We have witnessed a mass exodus of money as professional investors overseeing large holdings have reduced the money held in these funds. To defend themselves, the fund managers have been forced to make dramatic reductions in the fund price to discourage these sales (the largest for the moment being 17% made by Aberdeen) with most of the others dramatically closing the door on any further encashment. This turmoil is the evidence justifying those analysts who have long said that open-ended funds and unit trusts are badly designed to deal with property investments since they provide daily liquidity for an asset that isn`t liquid on a daily basis. Normally unit trusts invest in shares. There is no problem then if investors want to sell units; the fund manager simply sells some shares and the investor gets his money back within a couple of days. However where the fund is invested in property such as office blocks, shopping malls, government buildings, banks and the like, it can take months to achieve a sale and hurrying up this process results in fire-sale prices. This is the reason that the funds carry large sums of cash to cover the normal daily transactions. This time it would seem that Brexit has conjured up in the minds of some investors a vision of the country`s city centres being reduced to ghost towns as the UKs economy exits to the Continent! Under these circumstances it is not surprising that these property funds have had to use extreme measures to protect themselves while commonsense and sanity returns to the market. What is to be done now with these investments when the sale restriction is eventually removed? We can expect the prices to be lower as the result of property surveys and valuations carried out in the light of Brexit. On the other hand the property tenancy agreements are still in place and rent will still have to be paid. There is therefore no reason for a major reduction in the historical 3% to 4% these funds yield which is still very attractive when compared with the present “soon to be negative” interest rates. Maybe having taken the knock, it will pay to stay invested but with a smaller percentage of your portfolio. On the other hand perhaps this money could be better invested elsewhere. It is worth looking at what this actually means. Let us say that you had 25% of your portfolio in these property funds and they have taken a 20% hit. This means you have suffered a reduction of 5% on your total portfolio. Not a great outcome, but not one that merits reaching for the poison tablets. It means that you need the remainder of your portfolio to earn you an additional 5.3% to keep the status-quo. The same Brexit fever that has produced this property “annus horribilis” has produced a 10% fall in the value of Sterling and also contributed to a significant rise in the value of gold. All funds which are earning their money overseas and especially in dollars, have therefore received a rise in value of 10%. If you were also to be invested into the gold mining funds you would be receiving a double whammy. It is however a question for each individual to decide as to whether these conditions will continue whilst the terms for the UK exiting the European Union are hammered out. Also if Mr Carney continues to talk the value of Sterling down and Mrs Yellen in America continues to talk the value of the dollar up, then the Ocean Liner graph below is demonstrating a portfolio that has the right sort of mix to make the most out of the situation. This is the stuff that goose pimples are made of!