A Real Estate Lesson From 2008

(Bloomberg) -- Several big names in British investment have told investors they can't liquidate their holdings for the time being. It brings back uncomfortable memories of the financial crisis, when some hedge funds introduced similar-looking curbs on withdrawals.

While it's important to stress the differences between now and then, there are lessons from 2007-2009 on how investment firms should respond this time around.

The funds that Standard Life, Aviva, M&G, Henderson and others have "gated" invest in commercial property. The underlying assets -- offices, business parks, and shopping centers -- are inherently illiquid. In other words, they take time to find the right buyer even when things are going well.

The funds set aside some cash to meet the usually limited demand for redemptions by investors in ordinary times. That cushion lets the fund manager meet a withdrawal request without having to immediately sell off an asset at a discount price. Things are fine so long as not too many investors want to redeem.

This happened in the last crisis, and the problem went beyond property funds. Some firms imposed gates because the trading in credit securities that had been liquid suddenly dried up overnight. Or they did so because a sudden dash for redemptions exposed the fundamentally illiquid nature of securities that investors wrongly believed to be readily tradeable, for instance the holdings of some emerging market funds.

Today, there are doubts about the value of U.K. commercial property. There will also be concerns about securities tied to commercial and residential rents and mortgage payments (so-called mortgage backed securities). Exposure to these asset classes will be a central theme of forthcoming bank results. The concerns are nowhere near as acute as those in 2007-2009 about the value, and indeed the very composition, of complex credit securities. But property valuations depend on comparable transactions, and in a thin market these will be few and far between.

How should asset managers respond? One radical option would be to introduce guaranteed liquidity by underwriting redemptions up to a certain percentage of value using the asset manager's own capital. Firms would need to vastly expand their reserves to do this, but they could charge a fee to clients for giving them this security. In reality, most investment firms would balk at taking such risk. 

Alternatively, a simple lesson from the last crisis is to be as transparent as possible and communicate actively. Investors will assume the worst without full disclosure of portfolio holdings and their valuations.

The other lesson is that imposing "gates" should be a last resort. Some hedge funds chose not to do it in the financial crisis, and instead suffered huge outflows as a result. This good deed would have caused a lot of pain for the well-behaved fund. But when investor cash returned, the reward was a big marketing advantage: clients piled back in. Sometimes you keep something by letting go.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

To contact the author of this story: Chris Hughes in London at chughes89@bloomberg.net.

To contact the editor responsible for this story: James Boxell at jboxell@bloomberg.net.