Fitch suspects there is potential for the market’s reaction to the UK’s imminent departure from the European Union to be more severe than its reaction to the referendum result, particularly if there is a no-deal Brexit.

“Cash levels are marginally better than in mid-2016, when several funds gated due to investor anxiety linked to the UK’s referendum on EU membership,” Fitch said.

“But we do not think liquidity is strong enough to prevent withdrawal restrictions – should investors fear a steep market drop due to Brexit developments in the coming weeks.”

It also noted that withdrawals from property funds jumped in December, approaching the level seen after the referendum.

A spike in investor withdrawals from funds sparked a wave of selling activity by fund managers in the months that followed the referendum. The managers needed to free up the cash to meet these redemptions. Unable to sell properties quick enough, six property funds suspended trading while others continued to trade but imposed penalties of 10% to 15% – in the hope of discouraging investors from selling out.

“Rapid changes in sentiment, in relation to political declarations for example, could cause spikes in redemption requests beyond available liquidity, irrespective of the fundamentals of the properties held by the funds,” Fitch added.

The agency noted that listed real estate investment trusts (REITs), which are ‘closed-ended’, have also increased their cash levels. However, their intention is to position themselves so they can react quickly to investment opportunities that arise if asset values drop due to Brexit-related investor concerns.

Contagion risk

Fitch is concerned that a number of so-called ‘open-ended’ property funds will not be able to meet a potential surge in redemptions by selling assets, given the illiquidity of commercial property.

“Initially, funds with weaker liquidity would be more likely to have to implement a gate, but gating of one fund could spark contagion to other funds if it disrupts market confidence,” it continued.

“The UK open-ended property fund segment, although relatively small, could become the marginal seller of risk during the emergence of a Brexit-related stress scenario.

“In such a scenario, gating could cause negative investor sentiment to spread to other segments, which could ultimately affect financial stability,” it added.