Why institutional investors are shying away from reality

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The following article on Secondary Markets and Liquidity originally appeared recently in Der Fondsbrief, whose editor Markus Gotzi interviewed Alex Gadeberg, the CEO of Fondsbörse Deutschland to discuss why institutional investors remain reluctant sellers.

Liquidity is a value in its own right. It creates room for manoeuvre, enables new investments and allows underperforming holdings to be divested. Nevertheless, many institutional investors hold on to their property funds — even when market conditions have deteriorated. Alex Gadeberg, CEO of Fondsbörse Deutschland, has been observing this behaviour for years. But even in the market for retail funds aimed at private investors, certain misjudgements are becoming apparent.

"Even experienced buyers are complaining that the prices of the fund units they purchased last year on Fondsbörse Deutschland have fallen. But I do not consider this to be justified. Anyone who bought in at prices of 60 per cent of nominal value still receives a substantial return compared with products on the primary market — even if sellers are now accepting further discounts," says Gadeberg, whose exchange remains the largest trading platform for second-hand units in public funds. He also points to the stock market. Here, too, investors only enter the market at the absolute lowest prices in exceptional cases and sell at the peak.

The stability of secondary-market funds is also demonstrated by developments in specialised offerings for retail investors, for example from HTB and Asuco. As recently as early July, Asuco distributed around 12.3 million euros to the subscribers of its secondary-market funds. The payments range from 5.25 per cent to 7.0 per cent and are therefore at an above-average level.

Every month, the fund exchange facilitates transactions totalling around 15 million euros on average between the subscribers of existing funds and new investors. Property traditionally accounts for the lion's share of these transactions, with the negotiated average prices standing at around 60 per cent of nominal value. Shopping centres in Germany and the US are currently in high demand.

However, well-informed buyers are not only interested in property funds with a track record. Shipping funds involving container ships, bulk carriers and tankers are also in demand. The longer-term average price here stands at around 50 per cent of nominal value. At present, however, uncertainty caused by the unresolved situation in the Strait of Hormuz is having an impact on the Hamburg trading market, particularly in the case of liquefied gas tankers. There is also demand for second-hand units in funds specialising in renewable energy, aircraft and private equity, which, collectively termed "other investments," constitute the smallest segment.

The case for institutional investors to sell

Institutional investors are currently still largely holding back from trading their fund units. Yet they, too, could benefit from selling to professional investors. A key criterion is the swift provision of liquidity — even if sellers have to accept a price discount. This is because liquidity has a value in itself. All the more so as a buyer immediately assesses the assets on the secondary market, based on interest rate levels, letting risks, potential refinancing and ESG risks. The secondary market therefore generally provides a more realistic market price than a valuation report.

"Institutional investors are shying away from reality," Gadeberg observed. Yet they could avoid greater losses by selling. Typical risks include rising vacancy rates, higher borrowing costs, falling rental income and the need for costly refurbishment: "Anyone who waits in such a situation and reacts sluggishly to developments bears all the market and valuation risks themselves. A buyer might pursue a different investment strategy, accept longer-term capital commitments for strategic reasons, focus on future market cycles and therefore seek out precisely these properties — naturally at a discount." After all, who can rule out the possibility that market prices will fall further? Has the cycle reached its low point? Very few believe the cycle has already reached bottom.

Equally important is this argument: anyone who ties up their capital for years in a fund with poor performance cannot invest it more profitably, for example in private debt investments, infrastructure, renewable energies and bonds. Large institutional investors and high-net-worth investors should therefore not only consider the book loss, but also need to take into account the lost returns.

Fund trading also offers advantages to asset managers. It spares them the need to sell property during weak market phases, as we are currently seeing with open-ended special-purpose funds. As the best properties are sold off first, it is primarily the weaker properties that remain in the fund, which undermines the returns for the remaining fund unit holders. "Anyone who sells their units rather than redeeming them from the fund passes the risk on to the buyer and acts fairly towards the remaining investors," says Gadeberg.

Of course, this is only part of the market reality. There are often good reasons to hold on to the units, particularly if distributions continue to flow as forecast. For example, if investors believe in the quality of the properties and expect prices to recover. Added to this is a psychological effect: many institutional decision-makers shy away from realising a loss. As long as a loss is merely on paper, there remains hope of a future recovery. Only a sale makes the loss visible — and must be explained internally. Who wants to have to justify an obvious misstep to their superiors? Viewed rationally, however, the arguments in favour of trading shares are likely to outweigh the others, says Gadeberg: "As an independent broker, we help both parties to reach a clean, legally sound conclusion. We have been doing this with public funds for more than 25 years."

Whether institutional investors actually abandon their reluctance is likely to depend largely on how property valuations develop over the coming quarters. Should the pressure on portfolios continue to rise, the secondary market could become significantly more important.

This article is part of our ongoing series about Germany's secondary markets. Read the other articles in this series here: Series on Germany's secondary market