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Those who manage to rise to the challenges in respect of transparency and governance will differentiate themselves, as will managers who focus on product development to create innovative funds. The aftermath of the period of volatility represents a unique opportunity for product development. Whilst fund managers believe that communication with investors has improved, there needs to be more dialogue around these major issues. Communication with investors needs to be as much about listening to them as it is about informing them.
The nature of real estate as an investment asset
The original report noted that real estate is not a fungible asset. It is fundamentally illiquid and it is not straightforward to reduce a holding in a particular asset. Owning shares in listed real estate companies does create a fungible asset that allows an investor to increase or reduce their holdings as appropriate. The extent to which real estate funds approach this depends upon the characteristics of the fund. There is a trade-off between liquidity, volatility, performance and risk.
There is an increasing recognition of the consequences of this, and many managers of open-ended funds have, with the support of investors, moved to place restrictions on absolute liquidity, by limiting the capacity for investors to redeem their units. This is starting to become a spur to product development, which is discussed further below, but also raises important governance issues and the need for clear communication..
There is an increasing recognition amongst investors that there is no "right" or "wrong" answer to the trade-off between liquidity, volatility, performance and risk. Different investors will have different views, and those may change over time.
There was also a general perception that closed-ended funds are less transparent than open-ended funds. As investors’ capital is tied up for a longer period, this is a significant area of concern and needed to be addressed. Under pressure from investors, significant steps have been made in this area.
The level of operational due diligence undertaken by investors has risen dramatically. There is a much greater focus by investors on operational matters when allocating funds to investment managers for funds and separate accounts. The level of up-front due diligence has increased very significantly. Whether services are undertaken in-house or outsourced, a comprehensive and documented controls and governance environment is required.
There is an increasing tendency to expect ongoing comfort over the controls environment, through for example third party assurance in accordance with AAF 01/06 or ISAE 3402. This can be a double-edged sword. If this go well, comfort is provided to investors. If things go badly, the dirty linen is on display. Investors are increasingly intolerant of failings in this area. Investors appear to have become more tolerant of poor investment decisions, provided that they are within the agreed investment criteria, but significantly less tolerant of reporting, governance and compliance failures.
The original report observed that it is important that there is a continuing dialogue between fund managers and investors. Many interviewed expressed the concern that the collective memory in the industry might be short. A continuing dialogue and debate on these matters will hopefully ensure that this is not the case. Although a more demanding investor base represents a threat for some fund managers, it represents an opportunity for others.