David Prosser's Outlook: Fear stalks commercial property funds

New Star will shine again; Hanging up on TalkTalk at last
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The Independent Online

One by one, the giant commercial property funds are falling prey to market contagion. Yesterday's announcement by Scottish Equitable that investors won't be able to take their money out of its £2bn property fund for up to a year was just the latest attempt by an investment manager to cope with rising panic in the sector.

It is a crisis that is similar in some respects to the disaster that befell Northern Rock. The funds' difficulty is not that they have lost investors' money, but that much of the cash is tied up in long-term investments (in the same way as Northern Rock savers' deposits have been lent out to mortgage borrowers). If too many investors demand their money back all at the same time, the funds have to liquidate assets at firesale prices – hence the moratorium on redemptions imposed by Scottish Equitable and many of its rivals.

What managers imposing restrictions on withdrawals are seeking to avoid is a Northern Rock-style run on their funds. But denying people access to their money can only be a short-term solution. If you're an investor in Scottish Equitable's commercial property fund you may as well give notice today that you want your money back in a year's time. Doing so won't tie you into making the withdrawal – if the commercial property sector has recovered by then, you can leave it there – but you may as well have the option.

Equally, Scottish Equitable can't rely on a recovery in commercial property persuading investors to stay put (not that one looks likely any time soon). Over the next 12 months it will have to sell off assets in order to satisfy the redemptions due at the end of the moratorium.

This is the vicious circle dragging down the entire sector. And the more funds that are caught up in the mess, the greater the panic will be among investors in the rest of the sector.

There's a wider lesson to be drawn here. Hundreds of thousands of retail investors will be direct losers from the collapse of commercial property funds. It is yet another example of the contempt with which the fund management industry – investment management firms and the intermediary sector, including supposedly independent financial advisers (IFAs) – treats customers.

This, after all, is a sector that as recently as a year ago was still attracting new investments at a breathtaking rate. Leaving aside their holdings in pension funds and other institutions, retail investors own around £15bn worth of holdings in commercial property funds – a third of that cash was invested during the 2006-07 financial year.

Why such large inflows so near to the top of the property cycle? Because fund managers selling these products and financial advisers earning commissions on them were happy to ignore the gathering storm clouds in order to make as much money as possible at the top of the market.

One might characterise the attitude of fund managers and IFAs to investors as a little short-sighted. After all, someone who has been sold a disastrous pup is hardly likely to come back for more in the future. And yet investors do. Time after time, small investors fall for heavily hyped fund management vogues, only to lose large sums when their funds fall from favour.

These investors must accept some blame of course. They may be receiving poor advice – or being blinded by marketing – but they're the ones who actually sign the cheques and blunder repeatedly into the same trap.

One explanation for the phenomenon is the annual tax break that has been offered to investors for the past 20 years. Ever since personal equity plans (PEPs) were launched in 1987 – to be replaced by individual savings accounts (ISAs) in 1997 – fund managers and IFAs have had good reason to launch an annual sales blitz aimed at persuading investors to part with their yearly allowances.

Different years have featured different fads, to such an extent that regular PEP and ISA investors now have portfolios stuffed with an astonishing array of weird and wonderful in vestment products – a bit of emerging markets here, the odd junk bond holding there and, in more recent times, a generous helping of commercial property.

Still, don't expect this year to be any different. As the tax year end draws nearer, fund managers will once again be hawking their wares – not commercial property this year, naturally, but there'll be something else.

New Star will shine again

One fund management group whose property fund is in a healthier state than most is New Star Asset Management – ironic, given the collapse in its share price yesterday following a very disappointing set of results.

New Star saw this crunch coming earlier than most – in December, it changed the way its fund is priced so investors pulling out their cash were effectively charged a penalty on the withdrawals. This measure has apparently stemmed losses from the fund – which now maintains a cash buffer of around 20 per cent of assets.

If only the rest of New Star's offerings were so healthy. The company's woes reflect a downturn in the fortunes of some of its flagship funds – this underperformance, combined with corrections on world markets has led to a serious reduction in the fee income New Star earns.

Investors in fund management groups have to accept that their fortunes are closely aligned to the fortunes of the stock market itself. When markets fall, shares in fund managers almost always tend to fare even worse.

That said, yesterday's sell-off was surely overdone. John Duffield, still very much at the helm of New Star, can be abrasive and difficult, but he has an outstanding record of building successful fund management operations – first at Jupiter and then at New Star. One factor in this success has been his willingness to tell it like it is and to take action at difficult moments.

All fund managers experience lean years. The key for those running fund management companies is to work out who is worth supporting through tough times (and, by extension, who is worth jettisoning).

Mr Duffield has been here before and will no doubt be back here again – he shows little appetite for retiring despite a personal fortune. Some of his underperforming minions may not survive this difficult time, but shareholders in New Star certainly will.

Hanging up on TalkTalk at last

So it turns out that not even the magic of the iPhone enabled Carphone Warehouse to hit its sales targets in the run-up to Christmas. The company sold 50,000 to 100,000 fewer phones than it had hoped during its third quarter, despite having Apple's sexy gadget to tempt customers into stores.

The happier news for Carphone is that there has been no increase in the number of people leaving its TalkTalk broadband service, even though many users have now come to the end of their initial 18-month contract.

I have a theory about that, based on, admittedly, anecdotal evidence. The dreadful service I've received since signing up for TalkTalk has had a somewhat counter-intuitive effect. The prospect of yet another tortuous conversation with TalkTalk's call centres has persuaded me not to take my business elsewhere.

Until yesterday, that is. While Carphone's corporate team was busy explaining its third-quarter sales figures, the company's technical staff were happily employed terminating my own broadband connection – without notice or permission, of course. Apparently I'm no longer entitled to the service because I haven't also signed up for TalkTalk's home phone deal.

The success of Carphone's broadband service – it hopes to have 3.5 million customers by 2010 and is well on the way to hitting that target – more than compensates for the disappointing phone sales (and in fairness, the iPhone is more helpful for sales of contracts than pre-pay handsets, the mainstay of the Christmas market). I just hope all those new TalkTalk customers fare better than I have.

d.prosser@independent.co.uk

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