This article originally appeared in the 28 June 2019 issue of Estates Gazette.
Of course the suspension of Neil Woodford’s equity income fund raises questions about investor understanding of asset liquidity. There’s a no-less-serious question about the transparency of asset valuations.
Without knowledge of the quality of the underlying assets, through a transparent and open valuation process, investors cannot make informed investment decisions. They cannot decide for themselves, in the event of a crisis, whether they need to get their money out. They can only adopt the herd mentality.
The problem for investors comes when valuations are too infrequent to allow them to make decisions and when the relationship between fund manager and valuer – like that between Woodford and his fund supervisor – is too close to be entirely dependable.
An attempt by the EU to address this problem as part of the Alternative Investment Fund Management Directive is yet to be fully embraced in the UK, which lags mainland Europe in this regard. Brexit doesn’t make AIFMD redundant in the UK. In fact, it brings AIFMD higher up the agenda as funds seek to continue trading across Europe without the complexities of individual National Private Placement Regimes.
Introduced in 2013 in the fallout from the 2008-2009 financial crisis, AIFMD was designed to enhance supervisory practices, improve investor protection and promote cross-border competition. From a real estate perspective, a strong focus has been around risk management, particularly with regards to the Alternative Investment Fund Manager, which typically holds unlimited liability towards its investors.
Regulatory pressure was already growing before suspension of Woodford’s fund. In Luxembourg, for example, increased scrutiny is coming from the Commission de Surveillance du Secteur Financier. The CSSF’s concerns include competence and oversight, ensuring companies fulfil their legal obligations in terms of risk management, anti-money laundering, internal governance and reporting. Two banks were recently subject to fines of €250k and €4m respectively for non-compliance.
One result of this pressure for greater transparency is seen in the United States in the mainstreaming of daily valuations following the increase in defined contribution pension schemes. Daily valuations offer the investor daily mark-to-market pricing. The property value is adjusted when a material event occurs and applying a daily accrual of projected quarterly changes in value. In the US, this has enabled real estate investment managers to tap into the growing capital resources of the private pension market. Daily valuations are not yet common in the UK or Europe, but this may change with the shift to defined contribution pensions.
These risks won’t be news to many investors. We can interpret the divergence between the share prices of some listed real estate companies and their net asset values as a lack of confidence in those valuations. The divergence is often a product of the different viewpoints – valuation being principally rearward looking whilst investors are forward looking – but could be aggravated by investors’ lack of knowledge or understanding of the underlying assets. The divergence can of course be magnified in a fast-moving market – in a market downturn, say.
The trend of more transparency around assets and how funds are valued is a good thing. It’s happening everywhere in many markets and across many types of assets/investments and it’s what investors are coming to expect more and more. Those that ignore this direction will eventually find themselves offside or at a competitive disadvantage.
Ian Wimpenny is Altus Group’s head of UK advisory and a fund valuation specialist working across Europe.