During the last few weeks we have seen the M&G Property Portfolio fall by over 6% and then recover.
The sudden drop took place on the 12th May 2016, when M&G announced that they had moved the pricing basis of the fund from an offer basis to a bid basis. There was a notice put on their website explaining that the decision was taken due to a trend of sustained outflows from the fund, expected to continue in the foreseeable future.
I, like many of our members, contacted M&G to ask for further clarification. Most of us got little more than a polite reply encouraging us to look at the announcement on their website. One of our members did get a much more comprehensive response, which he has kindly allowed me to share with you …
“As an asset class, property recovered strongly in the period following the 2008/2009 banking crisis. Indeed, the asset class has produced above-average returns in the last three or so years. The combination of slowing growth in property asset values and the impending referendum on EU membership later this month is the most likely reason why some investors have chosen to reduce exposure to property, resulting in the Fund’s move to a net outflow situation. The M&G Property Portfolio experienced a price swing in March 2013 and also May 2013, with these price swings lasting only a matter of days. Further back in the history of the M&G Property Portfolio, the Fund experienced a more prolonged period of net outflows in the period leading up to, and during, the banking crisis. At that time, the price was calculated on a bid basis between November 2007 and June 2009. Both the Property Portfolio and its Feeder Fund are currently being priced on a bid basis and I hope you will appreciate that it is not possible to say when the price basis for the two Funds will revert to an offer basis.
Looking to the future, Fiona Rowley, the Manager, holds the opinion that in the next three years, returns from the asset class will result from rental income rather than coming from further increases in commercial property values. I must emphasise that this is the Fund Manager’s opinion and should not be taken as advice or a recommendation. It is not possible to make any guarantees about future performance or the way in which commercial property prices will move in the future.
You can find an explanation concerning the move of price basis on our website as follows:
To provide some more detailed information on the subject, as of 12 May 2016, the Fund’s price basis changed to reflect the fact that the Fund is currently experiencing a net outflow of cash. Being invested directly into buildings, the Fund needs to carry a large cash position, so there is no liquidity issue as such and the underlying value of the Fund’s assets remains unchanged. The price swing mechanism aims to ensure that the value of the Fund is not diluted for remaining investors when the Fund is cancelling shares, rather than creating new shares.
Perhaps I can expand further on the subject. Prior to the change in price basis, the Fund was receiving net inflows of cash. The amount of money going into the Fund, in terms of investor purchases, was much higher than the amount coming out as a result of investor redemptions. As the Fund is open-ended, further shares could be created to meet the demand.
In the scenario I mentioned, the Fund’s price was determined by the cost of creating new shares, which would involve buying more buildings. Property transactions are much more expensive, in percentage terms, than, say, share purchases. A figure of around 6%, representative of land taxes and legal fees, was therefore included in the price when the Fund was creating further shares to meet investor demand. Investors buying shares paid this cost, investors selling their holdings effectively benefited from a bid price which included the high costs of buying property. Since the shares being redeemed by the Manager could be re-used when the Fund was receiving net inflows of cash, withdrawals were priced to reflect the fact that the Fund needed to buy more underlying assets. In this manner, the value of Fund’s underlying assets is not diluted; an ‘offer/creation’ basis for pricing was used, because further shares were being ‘created’.
In the current scenario, the Manager has needed to move the price basis, as the Fund is experiencing a continual net outflow of cash. At present, the price is based on the value of the Fund’s assets, after deducting the cost of selling property (around 1.15%), as the Manager needs to cancel shares. This reflects the situation if the Fund were to actually need to sell some of the buildings it holds. I should like to reassure you that the Fund has sufficient liquidity to meet redemptions from cash. I hope you will appreciate that it would be unfair to offer a price based on creating shares to investors leaving the Fund, when shares are actually being cancelled. This could ultimately have the effect of diluting the value of remaining investors’ holdings.
With the Fund having a net outflow of cash on a daily basis, investors who sell receive the price as if the Fund is selling its assets. As the costs involved in buying and selling property are high, there is a difference of more than 6% when the price basis changes. We believe this to be a fair and equitable way of mitigating the risk that the value of remaining investors’ holdings is diluted by the net outflow of cash from the Fund. With the price being based on what the Fund would receive if it cancels shares and sells its assets, rather than the cost to the Fund of buying further underlying assets, investors who buy further shares will pay a more favourable price. Those investors selling their shares will receive a price based on the value of the Fund’s assets, less the cost of selling those assets.”
On the 3rd June 2016 M&G announced that the price had swung from cancellation pricing back to creation pricing.
Although we have covered the topic of bid / offer pricing in our newsletters and regular weekly emails, I thought that this response was particularly thorough, and I hope that it has given a useful insight into this aspect of investing in funds.