Lesson 15 of 25 · 6 min
Open-ended property funds, 2016 and 2019: a liquidity mismatch gated
Daily dealing on assets that take months to sell works until it is asked to work.
An open-ended fund creates and cancels its own units on demand, so its size follows investor flows. When the assets inside it are buildings, or unquoted companies, the fund has promised same-day liquidity on things that take three to nine months to sell. That mismatch is structural and is priced by nobody until it is tested.
It was tested twice in recent memory. In July 2016, after a United Kingdom referendum the previous month, several open-ended property funds suspended dealing or applied fair-value pricing reductions of several percent to units being redeemed. In 2019 a large open-ended equity fund holding unquoted and thinly traded positions was suspended and later wound up, with proceeds returned to investors over years at a loss. No fund is named, because the mechanism belonged to the structure and not to any one manager.
The order in which assets are sold is what makes this compound. Redemptions are met from cash first, then from listed holdings, then from the illiquid core. Each round therefore raises the illiquid share of what remains, so the investors who stay hold a fund that is less able to meet the next redemption than the one they woke up in.
The tools are the same as in the previous lesson: a pricing adjustment charges leavers for the cost of selling, a deferral queues them, a suspension stops the queue. Every one of them allocates the mismatch between leavers and stayers. None of them shortens the time it takes to sell a building.
Key terms
- Liquidity mismatch
- A promise of redemption faster than the underlying assets can be sold. The promise is the product; the mismatch is the risk.
- Fair-value pricing adjustment
- A reduction applied to redeeming units to reflect the cost of selling assets, so that leavers rather than stayers bear it.
- Residual illiquidity
- The rising share of hard-to-sell assets in a fund that has met redemptions from its liquid holdings first.
Worked example
Why the fund is less liquid after every redemption
Illustrative figures scaled down so the arithmetic is followable; they are not the reported amounts. A fund of 480,000 holding 38,400 of cash, 76,800 of listed securities and 364,800 of direct property, meeting redemptions of 14 percent.
- Redemptions to be met
- 67,200
- Cash used
- 38,400
- Listed securities sold
- 28,800
- Fund size afterwards
- 412,800
- Property share before
- 76.0%
- Property share afterwards
- 88.4%
480,000 × 0.14.
All of it.
37.5 percent of the listed sleeve.
480,000 − 67,200.
364,800 ÷ 480,000.
364,800 ÷ 412,800.
Not one building was sold and the fund became 12.4 points more illiquid. The next redemption request meets a fund with no cash and a thinner listed sleeve.
Check yourself
A fund of 300,000 holds 21,000 of cash, 45,000 of listed securities and 234,000 of property. It meets redemptions of 11 percent from cash and listed holdings. What happens to the property share?
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Educational only. Nothing in this lesson is investment, legal or tax advice, or a recommendation to enter into any transaction. Figures are illustrative and computed from the inputs stated in the lesson.