A property derivatives fund is returning money to major institutional investors in the face of “expensive pricing” in the futures market.
The inProp UK Commercial Property Fund, which invests in the Eurex property futures market, is redeeming approximately $200m (€175m) to its investors, which include CBRE Global Investors, Aberdeen Asset Management and M&G Real Estate.
The vehicle offers a synthetic exposure to the UK commercial property market and is used by most of its investors to provide a layer of liquidity to their direct real estate funds.
The structure of the vehicle is being kept “dormant” and could return to the market if pricing becomes attractive again, according to inProp Capital partner Paul Ogden.
“Several of the investors have said they still believe in the approach, they believe in the strategy, they like what it delivers,” he told IP Real Estate. “So we are keeping the structure dormant until the end of the year.”
InProp’s fund was launched in 2010, a year after the Eurex Exchange launched property index futures based on the total returns of the IPD UK Annual All-Property Index. But the fund’s management team deemed prices for IPD calendar year 2015 to be too expensive.
However, other investors still see value in the property futures market. Steven Grahame, manager of the IFSL North Row Liquid Property Fund, told IP Real Estate that the Calendar 2015 IPD Future was “currently good value”.
Grahame explained that prices for the 2015 calendar year future were cheaper than they were for the 2010 calendar year future at the same point that year. “Market commentators suggest returns for UK commercial property during 2015 will be circa 12-13%,” he said. “In 2010, the total return on UK commercial property was circa 15%.”
The UK commercial property market, as measured by the IPD quarterly index, returned 17.9% in 2014, far higher than most forecasts – the Investment Property Forum’s (IPF) consensus report suggested most investors expected a return less than 10%. Expectations this year suggest returns will still be in double digits, but significantly lower.
But Ogden said inProp’s view on pricing in the futures market was not determined by its market outlook. Under current pricing, the fund would effectively be paying a 7-8% premium to access IPD returns. “You would expect to get returns, loosely, 8% lower than IPD,” he said. “And that was the position we found ourselves in.”
According to Charles Ostroumoff, director at Arca Property Risk Management, the trading of IPD futures has grown steadily since inception, reaching the £1bn mark in 2013.
“When you trade an annual IPD futures contract, you are trading a one-year cash flow based on the annual movement in the IPD index for that calendar year,” he said. “Like any trade-able commodity, buyers are motivated to buy as cheaply as possible and sellers want to attain as high a price as possible.”
Ostroumoff, a property derivatives specialist, added: “Given that IPD futures have guaranteed cash settlement at the end of the year, determined by where the IPD index being traded settles, during a bull market expectations on pricing can run ahead of themselves to the point that buyers become sellers.”
Ogden said inProp would come back to property futures market once “sanity returns”. In the meantime, the company is proposing the launch of a fund with a more flexible strategy that could invest in real estate investment trusts (REITs) and REIT debt as well as property derivatives. The Trident fund – its name reflecting the three-pronged approach – will invest in the different assets depending on their relative value.
“The market inefficiencies that have pushed property futures to such a large premium also apply to other property-linked securities such as REITs,” Ogden said. “We are looking to take advantage of these inefficiencies in our new Trident fund which is looking to deliver a liquid, but lower-risk, alternative to simple REIT funds”.
The IFSL North Row Liquid Property Fund has already been employing a similar approach since it was established last year. Grahame said the fund “employs a relative value approach to take advantage of inefficient pricing across property derivatives, REITs and REIT debt”.
In the past three months, the fund has delivered a return of 4.28% with a volatility of 4.8%, according to Grahame – far lower than the 12% standard deviation that a pure UK REIT exposure would have delivered. The fund, he said, “seeks to provide core-like property returns, but with a level of volatility in keeping with core property rather than that of an all-REIT fund”.
Ostroumoff expects to see a growth in strategies that take advantage of market inefficiencies. Unsophisticated money often flows into real estate during a bull market, he said, “meaning a REIT manager receiving £100m of investment at the height of an equity market rally will have to buy REITs, even if they are trading at a vast premium to NAV”.
He added: “Such constraints are inefficient and limit returns. We will see the rise of the relative-value fund and the relative-value real estate fund manager over the next 10 years. The products exist to trade relative value, but the mandates do not.”