The IA is considering moving from the current UK Direct Property and Property Other sectors to a Direct & Hybrid Property sector and a Listed Property sector.
In the consultation paper, the IA’s sectors committee said it continuously assesses where current definitions are fit for purpose and if it is necessary to create whole new sectors as market practices change.
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This was the case for the direct property fund space, with the committee stating it was “aware that the asset allocation of funds classified to the UK Direct Property sector is changing and many funds are reducing their allocation to direct property in favour of a higher percentage allocation to listed property”.
The conversation about a property fund review began back in 2017 when the Financial Conduct Authority launched its consultation into direct property funds’ liquidity mismatch. This followed a wave of suspensions after firms failed to sell property assets fast enough to meet redemptions, as investors dumped stock following the Brexit vote.
Repeat bursts of gating funds have occurred in the years since, with some still suspended.
As it stands, the FCA has signalled that it is considering a 90-to-180-day notice period on direct property funds to tackle the issue between illiquid investments in a daily dealing portfolio.
However, the IA noted that this consultation was not formally completed and said that the “FCA may reconsult”.
“Given that relatively few open-ended direct retail funds remain, any FCA rule changes are expected to have a minimal effect on this consultation so this should not delay the IA’s proposed implementation timeline,” it said, something fund managers and analysts in the sector have long pointed out.
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Many firms have already transitioned their direct property funds to a ‘hybrid’ model, allowing them to invest in a split of assets, direct investment in physical property with indirect investment in property via global Real Estate Investment Trusts (REITs).
The proposed Direct & Hybrid Property sector would be open to funds that invest at least 70% of their assets in direct property or in a mixture of direct property and property securities, and invest an average of at least 40% of their assets directly in property over five-year rolling period.
The IA said that while it acknowledged that funds may hold different percentage allocations to direct property, committee members agreed that it was “more important to classify these funds together for investor clarity, given their focus on investing in direct property”.
According to them, this option would avoid the need for some of the funds to be moved to the Specialist sector if the number of traditional direct property funds falls below the minimum 10 mandate level.
The Listed Property sector meanwhile, would house funds with at least 80% invested in listed property securities.
The IA called this an “inclusive approach” as it ensures that the regional focused listed property were not lumped into the Specialist sector.
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A separate sector housing the regional funds to sit alongside a Global Listed sector was also considered but “felt to be too eclectic to be viable”, the committee added.
Oli Creasey, head of property research at Quilter Cheviot, said it was “interesting” that the Hybrid fund must have over 40% invested in in direct property.
“That is more than either of the existing hybrid funds that I know of (Columbia Threadneedle & TIME Investments) allocate to. It would be a surprise to see them not in the sector given it is a close fit in principle with what they do,” he said.
Creasey noted that the regional element of the Listed sector “could create some real divergence in returns over time”.
“I appreciate that a UK/EU only sector would be too small, but UK/US/global returns have varied substantially as the cycles are not aligned and there will be some big outliers when looking at relative returns,” he added.
“For those using it as a benchmark could make it basically impossible to outperform if a region other than yours is flying.”
The industry has until the 31 October to submit its feedback, with non-IA members invited to respond as well.
In its consultation response Aberdeen said it supported the proposed creation of a Direct & Hybrid Property Sector.
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“This reflects the evolving nature of property fund structures, and investor preferences, and aligns with our own strategic direction as we continue transitioning our direct real estate funds to hybrid strategies,” Euan Anderson, investment director, real estate, Aberdeen Investments wrote in its response, which was partially seen by IW.
Aberdeen was the second firm to move its direct property fund into a hybrid model back in 2024, following Legal and General’s initial move.
“This approach will help future-proof the asset class, ensuring it remains accessible and relevant to retail investors,” Anderson wrote.
“Importantly, we also recognise the increasing investor demand for access to private markets, which has become more pronounced amid the heightened volatility in public market asset classes. The proposed sector structure supports this trend by maintaining visibility and accessibility of funds with meaningful exposure to direct property, while also accommodating hybrid strategies that offer improved liquidity.”
Anderson also flagged concerns over the proposed 40% limit on the Hybrid sector exposure suggested that the definition includes funds that have a target of above 40% direct property as part of the Investment Objective and Policy.
“Given the FCA’s ‘Liquidity mismatch in authorised open-ended property funds review’ [2020] we are in a transition period of moving to a target allocation of 45% direct property, 45% indirect property and 10% cash in respect of both the abrdn Real Estate Fund and the abrdn Global Real Estate Fund,” the investment director stated.
“We therefore believe 40% seems reasonable, however, welcome that in the consultation there is reference to a grace period which should enable funds to rebalance their portfolios within a certain period of time should they fall below this threshold,” he wrote.