One in five managed funds may not survive the crunch

Hedge funds and property funds have emerged as the sectors most vulnerable in this bear market. Investors should monitor funds’ performance closely to avoid being caught by frozen redemptions or fund wind-ups.

Hedge funds and property funds have emerged as the sectors most vulnerable in this bear market. Investors should monitor funds’ performance closely to avoid being caught by frozen redemptions or fund wind-ups.

Chris Gosselin, chief executive of Australian Fund Monitors, says that as many as one in five funds might be battling for survival, with equity long/short hedge funds particularly vulnerable.

“If we look at performance, we’re probably going to see the 10% to 20% of funds that have underperformed the ASX 200 have probably got a limited shelf-life,” he says.

The combination of too much leverage, falling property prices and negative sentiment is hurting property funds. Hedge funds have been hit by short-selling bans, mass redemptions and an investor flight to cash.

After the spectacular blowups of Basis Capital, EQT Lehman Brothers Wholesale High Income Fund, City Pacific and Octaviar (formerly MFS), investors are feeling ruffled.

Of hedge funds, Ellerston GEMS Fund (EGF), which boasts James Packer as a non-executive director, will delist from the ASX. Unit holders in Everest Babcock & Brown Alternative Investment Trust (EBI) will decide on November 21 whether to heed calls by a major shareholder to wind up the diversified financial or follow management’s preference to delist.

For property funds, MacarthurCook expects its Asian Real Estate Securities Fund (MSA) will be delisted. The fate of the unlisted MacarthurCook Retail Property Trust is uncertain, with its two investment properties – one in Sydney, one in Melbourne – up for sale.

Earlier this year, property giant Mirvac decided to freeze redemptions for six months on three Mirvac AQUA funds. Now the $1 billion-plus unlisted property fund, Macquarie Direct Property Fund, has placed redemptions on hold and cut distributions. Management expects to see a redemption of Goodman European Logistic Fund and further redemptions of Goodman Australian Industrial Fund.

Orchard Funds Management recently surprised and disappointed its 14,000 investors by saying it would pay distributions annually rather than quarterly.

Gosselin says it will not just be underperforming funds facing redemptions. “Some of the good funds will have redemptions as well, simply because the investors – especially if they’re fund-of-funds – are having redemptions themselves,” he says. “So if there are fund-of-funds investing in underlying funds, which is where a lot of funds get their investors from, there’ll be redemptions irrespective of performance. So it’s certainly not going to be an easy time.”

Property funds expert Dugald Higgins says that over the past six months he has come across frozen redemptions for 20 unlisted property trusts, mortgage funds and property securities funds. The funds had $9.8 billion in total assets and more than 51,000 investors.

Higgins, the associate director of property funds research group Property Investment Research (PIR), says that although the fundamentals for the Australian property market are quite good, with vacancy rates comparatively quite low and rental growth generally solid, we’re only starting to see the surface of the troubles. He warns that “those who pushed the envelope hardest are going to find their values are going to unwind the hardest”.

“Listed property vehicles have been sold off more heavily than the broader equities market,” he says. “In terms of unlisted property funds; on the surface of things, they look like they have held up better, but seeing as they are unlisted, they can’t be valued on a market-to-market basis daily so they naturally will show the effects more slowly than their listed counterparts.

“There are some headwinds facing that market as a whole. They tend to operate in a space that has lower-quality assets. Given that that sector grew very quickly over the past five years… prices got ratcheted up really quickly, and perhaps past what the long-term reality should have been.”

Robin Bowerman, head of retail at Vanguard, says winding up funds is no easy business, and that some groups may keep funds alive for their revenue.

“A major fund group may have a fund that’s not taking in any new money, but it’s still earning revenue off that fund. If it just sits there, what it’s more likely to do is cut back on marketing, sales – any kind of product development expense – and just make sure that the revenue is protected and it’s run as it should be,” he says.

Rather than winding down funds, others may be quietly placed on the shelf, says Gosselin of Australian Fund Monitors. “There are certainly some funds that have closed down: Saltbush Funds Management has sold one fund to Pengana Capital and closed some funds; Pengana tends to focus on the fund of the moment and if they’ve got a badly performing fund, say their real estate fund, they tend to take the spotlight off that and really not do anything with it.”

For Gosselin, a clear sign a fund is in trouble is it stops reporting. “You think, ‘Why are they doing that?’ Normally, they say, ‘We’re not marketing at the current time.’ That’s a bit of a tell-tale.”

Anthony Serhan, of investment research firm Morningstar, says: “Some of the funds investing in narrower investment classes that have been showing some of the more volatile returns will obviously come under pressure.

“The reality is that inflows are down markedly, so it’s going to be more difficult to grow your business. In this sort of environment it becomes more difficult to reach critical mass… so smaller funds that haven’t reached critical mass are going to need to have very good balance sheets to survive through this period or they will come under pressure to be wound up.”

On the bright side, Serhan reckons that over the next year, there’ll be some very good buying opportunities. “If you’ve got a reasonable period to invest, there are clearly some assets that are very attractively priced; certainly more attractively priced than they have been in the past five years.”

This article first appeared in Eureka Report