What do you mean by ‘Capital at Risk’?
Most things we do every day involve some degree of risk, and that’s true when saving or investing. Familiar phrases “Past performance should not be used as a reliable guide to future performance” and “The value of your investment can go down as well as up” are standard risk warnings on any advert for financial services products like the TM home investor fund.
We want to be sure that anyone considering an investment in the TM home investor fund understands what the associated risks are and how those risks differ from, say, keeping your cash in the bank, or investing in equities, fixed interest or commercial property, or into funds which invest in any of those asset classes or a combination of them. Below we talk through some of the risks you should be aware of. Everyone considering investing in the TM home investor fund should also always read the Key Investor Information Document or the prospectus.
The value of your investment may go down as well as up:
If you have cash-based savings in a UK bank or building society, its value doesn’t fluctuate with changes in the stock market (a £10 note will have the same face value tomorrow as it does today). Over the longer-term though, prices of goods and services tend to increase – known as ‘inflation’ – so there’s a risk that the buying power of your cash will reduce. Please see the section on inflation risk below for further explanation.
If you invest in assets other than cash, perhaps by buying shares (known as ‘equities’), the value of those shares can rise or fall daily depending how well the company is performing and the availability of those shares on the market in relation to the number of investors who want to buy them. When demand is higher than supply the share price will usually rise, and vice versa. The trade-off for this short-term volatility is that, over the long-term, equities tend to give higher returns than cash, and to beat inflation.
Different asset classes behave in different ways and are affected by many factors, including supply and demand, interest rates, and the strength of the economy. In general, investors expect higher potential returns over the long-term for investing in assets which offer less security than cash – but these returns can vary. This is true of investing in residential property, as house prices can fall and there may be times when properties do not generate rental income.
Past performance is no guide to the future:
With so many factors affecting the value of any asset class, including residential property, it is impossible to give an accurate forecast of what an investment will be worth in the future.
High employment, a stable economy, affordable mortgage finance, a growing population and undersupply of available housing give favourable conditions for rising house prices and rents. Conversely, high unemployment, a weak economy, high interest rates and a significant increase in house building are factors which can lead to slower rises in property values or cause them to fall.
Although the fund aims to keep costs under control, increased costs can be brought about by a number of factors – including changes in legislation or the costs of managing or maintaining properties – and these can affect investment returns.
Risk of loss of capital: As the value of your investment can go down as well as up, if you there is a risk that you may not get back the amount you originally invested. The risk of this happening does reduce over time because, over the longer term, house prices have tended to increase. However, there are no guarantees this will always be the case and prices – and, therefore, the value of your investment – may fall. If you withdraw your investment when values have fallen, this may result in a permanent loss of some of your original capital.
Inflation risk: Prices of goods and services tend to increase over time. Although residential property values have tended to increase faster than the rate of inflation over the long term, there have been times when this has not been the case. If the value of your investment in the fund – which is driven to a significant degree by the values of the properties it owns – does not keep pace with inflation, the buying power of your investment will be reduced.
Liquidity risk: Unlike equities and fixed income assets, flats and houses do take time to sell because of the legal processes involved. Although the fund does aim to keep some of its investments in cash so that it can pay out to investors who want to cash-in (‘redeem’) their investments, there may be times when it experiences higher than usual levels of redemption requests. If the amount of cash it has available is insufficient, it may have to sell properties which could mean investors have to wait until those sales complete until they receive their money.
If the fund has to sell a large number of properties quickly, it may have to sell them at a lower price than could be achieved in normal circumstances. In these circumstances, the value of your investment could be lower than it was previously.
Short-term: Although property values have tended to increase over the long term, they can fluctuate in the short term. This and other factors – such as short term costs incurred by the fund – can mean that the value of your investment could be lower in the short term. An investment in TM home investor fund should be for the medium to long term, for a period of at least five years.
‘Tracking’ average house prices: There are a number of house price indices (HPIs) published each month. Some are based on property asking prices, some on data from mortgage lenders, and some are based on completed sale prices. Each index publishes what it has calculated to be the price of an ‘average’ house, and how that has changed over the past year and the past month. The number, type and location of the flats and houses making up their datasets varies, and the methods they use to calculate the average or to allow for the seasonal variations in housing market transaction levels can also differ.
The TM home investor fund does have a smaller number of properties than any of the datasets used by any of the house price indices which means it cannot fully replicate or ‘track’ their performance. Unlike the fund, the HPIs don’t incur any costs on property transactions or on management or maintenance. The fund also has to keep some of its money in cash, but it does receive income from letting its properties to tenants.
Because of these differences, the fund may perform better or worse than any given house price index.
Valuer’s opinion: The value of your investment in the fund is determined by the value of the properties it owns. The valuer, an independent firm of Chartered Surveyors, provide valuations to a professional standard known as ‘RICS Red Book’ methodology (RICS is the Royal Institution of Chartered Surveyors). Although this is a common standard used by all RICS surveyors, the valuation of each property is ultimately a matter of the valuer’s opinion and may be higher or lower than the price it might achieve if sold. If the fund needs to sell properties quickly it is likely it will need to accept a lower price, which would reduce the value of your investment.
Swing pricing: Costs are incurred by the fund when it buys or sells properties. Estate agent fees, Stamp Duty Land Tax (SDLT), solicitor’s fees and the costs of local authority searches mean that the fund may have to spend more than £1 for every £1 of property it acquires, or that it receives less than £1 of cash for every £1 of property it sells.
When the fund is growing because of new investors subscribing for shares, the price of shares is adjusted upwards to allow for the costs of buying more properties. If the fund is contracting, and may have to sell properties to pay out investors who want to redeem their shares, the share price will be adjusted downwards to allow for the costs incurred in selling properties. If it didn’t do this, the value of existing and continuing investors’ shares in the fund could be reduced by every property transaction it made.
For example, assume a fund had £1 million of assets and 1 million shares in issue at £1 per share. If it received a further £1 million of new investment and issued another 1 million shares at £1 per share, it would then need to buy properties with the incoming cash. If transaction costs were, say, 3.5%, it would only be able to buy property to the value of £965,000 because of transaction costs of £35,000. After completing the property purchase, it would have total assets of £1.965 million and there would be 2 million shares in issue, so the value of each share would have fallen from £1.00 to 98.25 pence. This dilution of existing investors’ value could have been avoided by setting the price of new shares at £1.035 per share.
A similar example could be given for when the fund has to sell properties – perhaps adjusting the price of shares down to reflect the costs incurred in sales transactions.
The TM home investor fund applies this principle, known as ‘swing pricing’, to the pricing of its shares. There is only one price at which investors buy or sell shares every day, and this is set at the higher level (known as ‘offer’ basis) when it expects to buy new properties because of incoming new money, or at the lower end (‘bid’ basis) when it may have to sell properties. At times when the size of the fund is steady, and it doesn’t expect to need to buy or sell properties, it may price somewhere between offer and bid (known as ‘mid’ basis).
There will be times when the pricing ‘swings’ from one basis to another, the largest movement being a swing from offer to bid or vice versa. Investors taking a long-term view should not be alarmed by these movements which are designed to protect those who remain invested from the impact of property transaction costs, as demonstrated in the example above.
The prospectus contains information on the maximum range the fund’s share price can swing. Actual transaction costs are regularly reviewed, and those costs used to set the actual pricing adjustment within that maximum range.