The asset management industry has been rocked by fears over daily-dealing funds that allow investors easy entry and exit, but hold assets that take far longer to sell. M&G’s freeze follows the shock collapse of star U.K. stock picker Neil Woodford’s empire this year, amid tougher scrutiny of managers who have been pushed to seek harder-to-sell assets in their hunt for yield.
“Woodford and M&G are different scenarios, but both point to the same thing,” Ben Yearsley, investment director at Shore Financial Planning said. “You shouldn’t hold illiquid assets in
GAM Holdings AG, H20 Asset Management and Lime Asset Management Co. have also grappled with liquidity crises in the past two years.
The M&G money pool was one of seven major U.K. funds that halted trading in the aftermath of the 2016 Brexit vote, when spooked investors demanded their money back. In a rush to sell properties quickly in order to raise cash, many funds disposed of buildings that remained attractive to buyers even after the Brexit vote, such as London offices or warehouses.
That’s left funds like M&G with a higher relative exposure to retail properties that have proven tough to sell. Retailers have been closing stores and seeking rent cuts in an attempt to compete with online rivals, sending retail property values plunging.
Pensions hold large weightings of fixed income so they can match assets with future liabilities. That means they need to have a better return on their other holdings to ensure the total grows enough to succeed in meeting those liabilities. The low interest rate environment over the last decade, and more, has represented a major challenge for the sector and its effect is cumulative. The longer interest rates stay low the greater the pressure on pensions to find alternative ways of boosting returns.
The growth of the alternatives industry has been boosted by the adoption of modern portfolio theory and process driven investing. However, it went into overdrive when the low interest rate environment forced investors into anything that promised a higher yield. The problem with alternatives is one often substitutes liquidity for returns. Property, infrastructure, privately held businesses, water rights, art and other collectibles all have value and some have attached income streams but none offer daily liquidity.
That fact was made clear to investors during the credit crisis when liquidity evaporated and funds were forced to sell what they could rather than what they wished to meet redemptions. That created demand for a new market segment; alternatives with daily liquidity. This was achieved by buying puts on the stock market while also hold illiquid assets. The rationale was that in the event of a crisis the short strategy would pay off and assist in meeting redemptions so that the illiquid assets could continue to be held. Unfortunately for the creators of these structures, the stock market has been on a decade-long uptrend so these funds have underperformed in a major way.
So, how do you build an alternatives portfolio that has any hope of performing in line with the market. The easy answer is to dispense with hedging. It’s not ideal but when the values of startups were accelerating higher and the time to get to unicorn status ($1 billion valuations) had dropped to a matter of weeks, what choice did funds have? They could have simply stayed away but the cost would have been underperformance. The compression in private asset valuations, not least following the failed IPO of WeWork, has highlighted the exposure many funds have to alternative assets.
The failures of major asset managers to manage this risk highlights just how pervasive the practice is. The cautionary note is many investors have no idea their pensions are invested in these funds and are unaware of the risks being taken on their behalf to generate the returns necessary to fund their retirement.
Another point that is becoming increasingly clear is none of the funds mentioned in the above article are specialists in private assets. The were encouraged in by the promise of outsized returns but ultimately did not have the expertise to manage their exposure. The performance of specialist alternative investors like Brookfield tells a different story. The company has focused more on income producing real estate and infrastructure than unicorns and has successfully sidestepped the challenges faced by less experienced funds.
Blackstone also remains in a reasonably consistent medium-term uptrend and its focus on rental properties is well understood.
The animating factor behind M&G’s troubles is a fresh iteration of the retail apocalypse where mall and retail properties are plummeting in value outside of the primary high street and tourist areas. That is creating some distressed valuations in the property sector and the efforts by Brookfield, Greystar and Blackstone to pick up student accommodation provider IQ Student Accommodation suggests bargain hunting amid the debris.
The broader picture is the UK is trading at a significant valuation discount to other developed markets. With the prospects of a Conservative majority increasing and an end to the Brexit ordeal insight, there is clear scope for that discount to be unwound. The recent strength of the Pound suggests increasing interest in UK assets.Back to top