Investors and managers have come together to identify five pillars on which Europe’s open-ended fund sector should be built. Maurits Cammeraat explains
‘New normal’ may be an over-used term, but it remains a handy way to define a world in flux. A world in the throes of unfamiliar and daunting geopolitical change, with unsettling implications for economies and markets. A world in which investors need to know they can access their money promptly, if necessary.
Events such as the UK’s vote to leave the EU are a convenient reminder that, in extremis, the first impulse of some investors is to dash for the cash.
But liquidity has been a long-standing issue for real estate. And while Brexit seriously tested the theory that open-end funds – in particular – are liquid, it was also an urgent prompt for the industry to address the liquidity question once and for all.
Market participants will not need reminding that the issue is complex, but that must not be an excuse for inaction. If we cannot resolve it, the regulators will move in and we will end up with the sort of cross-asset class approach that is bound to result in a blunt instrument. What is actually required, however, is a nuanced solution.
Happily, work is underway. In October 2016, INREV updated its 2015 report Investor Perspectives on Indirect Real Estate Liquidity. It highlighted the facts that underpin the liquidity debate: that indirect real estate is relatively illiquid compared with equities and bonds; this illiquidity is owing to the nature of the underlying assets and the complexity of trading heterogeneous indirect holdings in a market with a transaction volume smaller than that of the direct real estate market.
The study also revealed three priority factors that investors felt could improve the situation. They mentioned improved transparency, document standardisation and an increase in the size of the indirect market.
More recently, INREV’s secondary market and liquidity committee has taken a lead in bringing together the full range of market participants, including investors, fund managers and advisers. The focus of the discussion has been on open-ended funds. It is a dialogue that will continue, but it has already resulted in the identification of five pillars upon which any liquid open-ended fund should be built.
These pillars reflect the priorities from the study and take them one step further. The objective is to identify the areas of common agreement and create a framework that becomes standard practice across funds, national jurisdictions and, ultimately, all geographic regions.
As with so much of the industry, consistency and standardisation will be critical to the successful eradication of the liquidity conundrum.
The pillars themselves delve into a degree of technical detail, but the headlines are clear and easily understandable, and are worthy of note. The numbered chapter headings in the pillars document read as follows:
• Clarifying the terms and rights of redemption;
• Creating access to secondary market trading;
• Establishing and publishing a fair price;
• Disclosure to potential new investors;
• Respecting local customs.
Chapter three deals with arguably the most contentious of the problems to fix: pricing. It is hard to fix because it is complex. But fix this and much of the rest of the liquidity issue is likely to slot quickly into place.
There are inherent conflicts with pricing based on the divergent vested interests of individual market participants; differing regulatory and accounting standards between countries; and national customs and behaviours. There are also sound arguments in support of probably all of the various pricing methodologies that are regularly debated.
But the industry needs to reach some conclusions on this, and fast. The existence of multiple pricing options is perhaps the biggest roadblock to progress.
Establishing a standard approach to NAV calculations would certainly help move things forward. INREV is working with a group of fund managers to clarify and evaluate the different pricing methods, hopefully resulting in one preferred method. But there will likely be no silver bullet.
Despite the fact that INREV NAV was never intended for pricing, it will be one of the methods examined as it is increasingly being adopted by investors and fund managers across Europe.
The way different jurisdictions address some of the points that are highlighted in the INREV pillars document will have a positive impact too. There are best practice lessons to be drawn from some of the more mature markets, such as the Netherlands and the UK.
How these countries have structured and operate their secondary markets are an interesting case in point.
Arguably, the UK offers the most well-defined and efficient model, where investors can trade units without recourse to fund managers. The level of secondary-market transactions in the UK is made possible by a number of agencies and market brokers. And one of the important reasons for the growth in the secondary market has been the ready availability of market and fund data, with clearly established pricing mechanisms.
We are back to transparency and standardisation. We all know it is a question of balance and the current conversation is very much aimed at achieving this – not just in Europe but, working in partnership with PREA, NCREIF and ANREV, across the globe.
Progress is being made and there is a mood of optimism – but also a sense that things need to happen fast to reach the hallowed state of free-flowing liquidity in open-ended funds, before an inappropriate solution is imposed on the industry from outside.
Maurits Cammeraat is director of professional standards at INREV