As funds approach their termination dates, LPs and GPs debate whether to extend or liquidate. Is it time for reassessment, asks Rachel Fixsen

Changes are afoot in the world of non-listed, closed-ended property funds, as fund managers and investors grapple over whether to extend or liquidate. Funds with a pre-2008 vintage are now approaching their termination dates and discussions about what happens next are either taking place or are about to begin.

According to the most recent fund terminations study from the European Association for Investors in Non-Listed Real Estate Vehicles (INREV), between 32 and 38 funds are due to terminate in every year between 2012 and 2016. This means that 176 funds will come to an end over that four-year period, with a current gross asset value (GAV) of €68.6bn – or 29% of the entire volume of Europe’s non-listed funds universe.

In June, Legal & General Property (LGP) tackled the issue of what to do with one of its key property funds, which was due to terminate in 2015, by inviting the fund’s investors to come up with recommendations.

LGP’s £780m (€915m) Industrial Property Investment Fund (IPIF) set up a seven-strong investor committee representing the interests of all unit holders, to design new terms for the fund. After meeting several times in private, the investors, including major multi-managers such as Schroders, Aviva Investors and CBRE GMM, drafted recommendations that were approved unanimously at the fund’s EGM.

The fund was extended to 2020 and given a clear rolling process after that, and an exit mechanism was introduced giving unit holders a five-yearly option to leave without causing the fund to close.

The 100% threshold for resolutions was reduced to 90%, and the flexibility added to raise future equity.

Dan Batterton, business development manager at LGP, expects such changes to become more common features among real estate funds in general in the future. “The investors who provided us with advice on this are asking other managers to act in the same way,” he says. “This approach is definitely going to be used again, and will hopefully be seen as a sensible way forward.”

Mark Adcock, portfolio manager at CBRE Global Multi Manager, says LGP’s process of getting investors to set out their objectives up front was more efficient than the usual procedure adopted by funds in the run-up to termination. “By contrast, the approach we often see – where investors are asked to react to the manager’s proposals – can lead to a protracted process which fails to reach a consensus,” he says.

“The absence of the manager from the initial discussions encouraged investors to speak openly, find common ground and identify items that required further deliberation,” he says, adding that this was helpful in building a consensus among investors.

INREV’s fund termination study, published late last year, focused on funds due to terminate between 2012 and 2014 and noted that the dislocation of the European property market is creating uncertainty around fund terminations. Because funds consequently need more time to address whether to liquidate or extend, and how to do this, decisions are being made closer to the action termination date.

At the moment, the most likely option for funds facing termination, according to the study, is extension rather than liquidation, with 59% of funds going down this route, against 33% opting to liquidate.

While some fund managers can make discretionary decisions to extend, in the current climate investors are keen to make sure they have stricter control over these decisions, INREV found in the study.

CBRE GMM is in discussions with five funds at the moment in the UK alone, as well as others in international markets. While some discussions relate to extensions of closed-end funds, others involve modernisation of open-ended funds, says Adcock.

“A significant extension of a closed-end fund will require stakeholders to look at areas such as governance – formation of an UAC [unitholder advisory committee] and changes to voting majorities – leverage and other risk restrictions, exit processes including liquidity windows, and fee terms,” he says.

Fees are often the most contentious, says Adcock, adding that one of the key changes CBRE GMM has advocated for some time is the move from a GAV-based management fee to one based on NAV.

“Another change in the industry is that investors, including CBRE GMM, require an increased level of transparency and reporting from managers,” he says.

Peter Hobbs, managing director and head of research at IPD, says some funds are extending because they belong to a particular vintage where assets may be good but difficult to sell at advantageous prices in the current market.

“But there are other factors as well – such as a desire from investors to invest in the longer term,” he says.  “We’re seeing a big appetite for open-ended funds, and in that context, if an unlisted fund has the opportunity to change to an evergreen fund, then that may be positive.”

However, choosing to extend rather than liquidate is only possible if the fund has the confidence of investors, he points out. In negotiating terms for a fund extension, investors are expressing a demand for more transparency.

“A lot of investors want more control and transparency over their fund investments, as they achieve through their separate accounts and club deals,” he says. “In this environment, fund extensions are often associated with greater disclosure of the drivers of performance, and risk, within the portfolio.”

These trends are reinforced by the introduction of the Alternative Investment Fund Managers Directive (AIFMD), he says, with managers taking the opportunity of extensions and AIFMD requirements to reset their relationship with investors.

Whether funds facing termination actually extend or liquidate depends on the style of the fund, the INREV study found. Core funds are more likely to choose extensions, with only 21% of funds in this category saying liquidation is the most probable option, while 50% of opportunity funds were found to be most likely to liquidate.

The country focus of a fund is another factor determining what it is likely to do at termination. While only 30% of UK funds chose or were likely to choose liquidation over extension or roll-over, 46% of other single-country funds were planning to liquidate, or had already done so.

Extension negotiations are seen by investors as a good chance to talk about changes they think should be made to fund structures, strategies or fees, the study found. They want to see these adjusted to current market conditions, lowering management fees but also the hurdle rates for performance fees and target returns – the aim being to give the fund manager enough incentive to go on with the agreed strategy in the changed market conditions, INREV says.