Fitch warns property funds require tighter regulation
Credit rating agency Fitch Ratings has claimed investors will remain exposed unless there is tighter regulation of or changes to the redemption terms of commercial real estate funds.
It follows last week's decision by Aviva Life and Pensions to prevent investors from withdrawing their money from two commercial property based funds for six months after a recent increase in outflows.
Fitch Ratings said similar liquidity risks exist in other European commercial real estate funds which allow funds to be withdrawn on a daily basis and it believes investors will "remain exposed unless tighter regulation or altered redemption terms are introduced to reduce liquidity mismatches."
A shift towards regulating such funds in a way that would prevent frequent withdrawals would be one way to reduce the risk, it said, and this would also lead to better credit ratings in the fund sector.
"We regard liquidity mismatches as a major structural flaw that is likely to become more evident if the European CRE sector, or investor sentiment towards it, weakens," it said in a statement.
"There is also the risk of contagion. If a fund experiences a spate of outflows, investors in other funds invested in similar assets may move fast to redeem their holdings to limit exposure to declining asset values after forced sales."
It also claimed that if a fund is "gated", in the same way as the Aviva funds, the publicity may increase this contagion effect, while at the same time possibly causing wider reputational damage to the investment manager and the sector.
"Banks or other lenders may also be affected if an affected fund uses them for debt financing or liquidity facilities," it said.
But the agency said it does not think that a significant contagion to the broader financial system is likely.
This is because CRE funds are typically small, representing only about 2% of mutual funds globally.
The Aviva case is not unique. Two high-profile funds in the UK also restricted withdrawals last year after a significant rise in withdrawals by investors.
The Bank of England and Financial Conduct Authority are both reviewing the vulnerabilities in such funds and Fitch Ratings predicts this may lead to more stringent regulation of the sector.
"The Bank of England has said that redemption notice periods should reflect the time needed to sell the required portion of a fund's assets without discounts beyond those captured in the price received by redeeming investors," it said.
Fitch Ratings said that while holding large quantities of cash reduces the liquidity risk in such funds, the investment returns targeted by such instruments limit how much cash their managers are generally willing to hold.