News has reached us of the suspension of redemptions from the Brandeaux Property Funds: Brandeaux_Update.

These were open-ended UCIS schemes, investing in purpose built student accommodation and it appears that this is a liquidity issue – they do not have the liquidity to honour redemptions.

They have cited uncertainty around the student accommodation market and the new restrictions on the promotion of UCIS as the reasons behind the suspension.

It’s worth examining this a bit further, because there are a couple of instructive points worth drawing from this:

Firstly, liquidity

There are three ways to create liquidity

1) Have a massive pool of cash. This is too inefficient to consider

2) Sell the underlying assets to raise cash. Difficult with property.

3) Match buyers and sellers. This is fine, as long as there are similar numbers of buyers and sellers. Once there isn’t, you have a liquidity problem, just like Brandeaux.

Brandeaux, Liquidity, Fund Closures and the New Regulations

One way of managing this is to have a closed-fund. This is essentially option 3, but the market sets the price. Investors buy and sell shares in the fund, based on their assessment of what a share is worth. This creates liquidity in the same way the stock market is liquid – there will nearly always be buyers, at the price the market thinks is fair.

(Note: you still have a  problem, if the market doesn’t think your units are worth very much, yes, you can sell, but not at the price you want. Liquid, yes. But you can still suffer a catastrophic loss)

I’m not sure why you would have an open-ended fund that invested in illiquid assets. Redemptions will always be somewhat problematic in this scenario.

Key take away: when your clients say they understand that an investment is illiquid, do they really know what that means?

Secondly, valuations

Open or closed, investors rely upon trustworthy valuations of the underlying assets to tell them what their investment is worth.

So far there has been no suggestion of impropriety at Brandeaux and I do not know enough about the funds to make any judgements.  But hypothetically, if a fund manager arranged their own valuations they could inflate them, give the impression of good performance and pay any redemptions from new investments. They’d only be discovered once new investments dried up.

Key take away: an insistence upon independent valuations to ensure you are not looking at a ponzi scheme is essential. (I learned this the hard way)

Thirdly, regulation

What if the Brandeaux funds have been performing excellently, but because the new UCIS regulations have meant that new buyers have dried up there is no liquidity? (Again, this is hypothetical, I have no inkling on the performance of the funds either way)

Current investors now no longer have the liquidity they need to exit and new investors do not have the opportunity to invest in a good fund. This could be considered an unintended consequence of the new regulation.

In reality, I think it will probably be a price that the FCA view is worth paying, if that’s what it takes to keep retail investors out of unsuitable funds. And the occasions when the regulations actually lead to missed opportunities for investors will be few and far between. However, it does show how regulation is a blunt tool that can distort markets and it would be unfortunate if investors in these fund suffer losses and regulation is the culprit. 

Thanks
Dan