Open-ended property funds have, perhaps fairly, come in for a lot of criticism over the last decade after flaws in their structure became very apparent.
With numerous suspensions and closures, very few now remain and it is clear that the current structure may not be fit for purpose given the illiquidity mismatch on offer for investors. Work is being done on rectifying these structures, as well as introducing long-term asset funds, but property funds as we know them today have severe limitations.
We have recently embarked on the third stage of our investment trust engagement programme, this time focused on Real Estate Investment Trusts (REITs). This has given us the opportunity to also engage with our open-ended holdings in the property sector and take a temperature check on the industry.
Now, there are some key differences in investor expectations between open-ended funds and REITs, primarily due to their structure and the fact one is listed on the stock market. However, while our expectations for governance of investment trusts is naturally higher, this is one area where property funds are letting investors down.
In open-ended funds, management is overseen by an authorised corporate director (ACD), which has a board of directors responsible for the management of the fund. The Financial Conduct Authority (FCA) has indicated that 25% of the members of the ACD board (or two people, where there are fewer than eight people) must be separate to the ACD. The directors are proposed by the ACD and approved by the FCA, unlike the directors of an investment trust which are elected by shareholders.
Immediately, open-ended funds lose a vital connection to their investor base.
There is a structure beneath these directors that directly manages the funds; the directors primarily review documents during their quarterly meetings and approve documents rather than diving down into discussions of specific underlying assets. This setup significantly reduces the hands-on involvement of directors in the day-to-day management of the funds, which contrasts sharply with the more active roles seen in investment trust boards. This distinction is vital for investors to understand as it directly influences the governance and oversight of their investments, especially given the sometimes and complex and often illiquid nature of these.
Interestingly, an ACD can serve as the director for an umbrella fund that encompasses dozens of underlying OEICs. This means that an individual director might sit on the board of hundreds of funds.
It is unsurprising therefore, that during this exercise we were the first investors to try to meet the board for one property fund. The open-ended structure leads to an opaque governance system, complicating board evaluation. With the controversial nature of property funds, and the regulatory issues still to be resolved, we would like to see far less over-boarding in the ACD universe and instead have the expertise available in the market properly advising the managers of the fund and challenging appropriately.
This is much easier with REITs, where we expect the chair to be aware of the time commitments of each candidate and to have conversations with directors taking on further appointments. Clearly REITs are not a beacon of perfection either, however, as long as directors can dedicate the necessary time to the trust, having multiple board positions is a benefit as it allows the director to keep their knowledge updated and relevant. This practical approach ensures that the board remains robust and well-informed, leveraging the diverse experiences of its members.
Open-ended funds have an over-boarding issue and it raises the question of whether investors in property funds would benefit from an investment trust board structure, similar to that of closed-ended funds, even if it entails a marginal additional cost.
Despite a lot of progress over the years on governance, it still matters greatly to investors, particularly as environmental and social issues perhaps lose their lustre of recent years. The AIC’s latest ESG Attitudes Tracker found governance is now tied with environmental issues as the most important factor within ESG when assessing an investment. Furthermore, ‘transparency and disclosure’ is now the number one ESG issue, highlighting investor’s desire for honest and well-run funds.
Property funds have had to contend with a number of events conspiring against them. If they want to see any sort of revival in the short- and long-term then governance has to be a priority.
Property funds can learn a lot from their REIT counterparts. Having committed and dedicated independent directors, providing robust challenge to the fund manager is vital for the smooth running of a fund and will ultimately lead to better investor outcomes. Without good governance, open-ended property funds will continue to be held back even if problems with their structure can be fixed.
