With news of the latest court action taken by a local institutional investor against Bank of Valletta (BOV) and its associated fund administrators, we see that the “silly season” is not that silly at all and the investor may face a bumpy ride during court proceedings. The doldrums among fund investors is not unique to Malta, as other advanced economies have also suffered badly. To start with, Berlin’s property fund plan caused the jitters as the sector faced a shake-up after providers of the popular investment vehicles clashed with the German government. These clashes involve new reform plans aimed at tightening rules for fund advisers and administrators. Berlin has proposed tough new rules for the funds meant to boost confidence in the sector, but even in draft form they have been misunderstood and we see at least three funds closing temporarily for redemptions due to a wave of withdrawals by nervous investors. Here one must add that open-ended property funds have existed in Germany since after the war. They constitute one of the most popular investment classes in Germany, with some three million private investors, as well as institutional investors, and about €90 billion under management. But there were some bad apples in the barrel. Thus the regulator insisted on introducing severe tests that coincided with the financial meltdown when more than a dozen funds were forced to close down. As a result of protests by angry investors, the German government has seized on the need for reform to try to address one of the problems inherent in the sector. All this highlights the incongruity between investors’ preference for short-term access to their funds, which is not always possible due to the long-term nature of the funds’ property investments. In times of heavy demand for redemptions, the funds cannot satisfy investors’ requests without reverting to a drastic and destabilising fire sale of properties.

Across the Atlantic, one cannot but mention the serious fall in value of the Morgan Stanley property fund. This faced a massive $5.4 billion loss focused squarely on bogus property acquisitions that shed nearly two-thirds of its value following the sub-prime crisis.

Morgan Stanley recently reported such bad tidings to investors in its failed Real Estate Funds VI International Fund. Experts believe it will be the biggest single loss in the history of private equity real estate investment. Over the past 20 golden years, Morgan Stanley’s real estate unit was one of the biggest investors in property around the world, writing $174 billion in deals since 1991, mostly with money raised from pension funds, college endowments and foreign investors. But the shake up started when massive losses were incurred from investments in properties such as the European Central Bank’s Frankfurt headquarters, a big development project in Tokyo and Inter-Continental hotels across Europe, among others.

Back in Europe, this time in Spain, we notice how its main banks had extended themselves heavily in property loans and, of course, a number of property funds collapsed when the market faced a severe meltdown. Falls of more than 30 per cent have been registered in prime property in both Spain and neighbouring Portugal. It is not surprising that there were five banks in Spain that failed the recent stress tests. These were regional savings banks, which racked up heavy losses following the collapse of the Spanish property market and of course ruined the funds industry linked to lavish real estate developments. In particular, the five banks include Caixa Catalunya, Caixa Tarragona y Caixa Manresa which would require a capital injection of €1,032 billion, while CajaSur, needs a top-up of €208 million; the merger of Caixa Sabadell, Terrassa and Manlleu, requires €270 million; further restructuring included the group Banca Cívica, consisting of Caja Navarra and the Canary General de Burgos, €406 million; and the merger Caja Duero y Caja España, €127 million.

The dire consequences of the Spanish saving banks’ collapse are mostly due to an aggressive “get-rich-quick” investment strategy administered in recent years. As stated before, it centres on the crumbling of the property market. Typically, investors witnessed how Caja Madrid posted €3,000 million in these bonds hybrids marketed heavily through its network of offices, but these retail products did not stand up to scrutiny. They

faltered in reaching the promised returns. These investments were offering a fixed high interest rate of seven per cent during the first five years and 4.75 per cent on three-month Euribor, starting from the fifth year onwards. As can be expected, Standard & Poor’s has downgraded the rating of the Spanish banking institution’s

preferred ‘BBB-’ to ‘BB’, the equivalent of junk bonds.

So what about Malta? Did investors also feel the jitters on funds that did not perform? The answer is that we were luckier than the Spanish investors because we did not have banks that failed; in fact BOV passed its stress test with flying colours.

However, there is a fly in the ointment. A judicial protest was sent by Finco Treasury Management against BOV and its associated fund administration companies, accusing them of irregularities resulting in an alleged consequential loss in a Property Fund. Finco’s opprobrium is quite understandable after reading through their judicial protest, having suffered a €50 million fall in net asset value of a supposedly low-risk SICAV with little volatility. Finco claimed that the SICAV and VFM, as director and manager of the SICAV, VFS and BOV, failed in their duty to abide by and comply with the terms and conditions of the Investment Restrictions in the Offering Document, not to mention ignoring the strict licence rules, including the Standard Licence Conditions and PlF’s rules. The main problem was encountered in two funds administered by sub-fund manager Belgravia as authorised under the fund rules. The allegations go on to state that, as an investor, Finco trusted La Valette Multi Manager Property Fund on the basis of the Offering Document when the fund was originally set up on 13 September 2005. It stated as its principal investment restrictions that the Fund may not itself engage in high gearing. However, the Fund may, at any time, only borrow up to 10 per cent of its Net Asset Value to meet short-term liquidity and cash flow requirements. While fund rules limited the exposure of debts to 100 per cent of the net assets, the Belgravia European Property Fund had over reached a gearing of 1286 per cent.

Finco also added that both VFM and VFS confirmed that funds managed by Belgravia where the fund made high value investments – the Belgravia IFN China Property Fund and the Belgravia European Logistics Fund – have never so far published any audited accounts. Their €17 million investment in the Belgravia European Property Fund has lost in excess of 90 per cent and is reported to be only worth an estimated €1.3 million, while other investments originally valued at some €47 million have fallen to €18.5 million. Belgravia Fund’s directors are being criminally investigated for fraud by the police in Jersey, and its shares have been suspended by the Jersey Financial Services Commission.

It is clear, Finco added, that when the VFM made huge investments worth many millions of euro, it could not have had in its possession “clean audited accounts” of the companies in which it had invested. This, Finco alleges, is further proof of a lack of due diligence on the part of the SICAV and VFM as director and manager of the SICAV, and on the part of Insight as sub-adviser of VFM. For their part, BOV and Valletta Fund Management (VFM) said that they have kept the development of the Property Fund under constant review, and they are fully aware of the performance of the fund and of the developments concerning the underlying investments held by the fund.

To conclude, for the multitude of Maltese investors who lost more than 75 per cent, such summer jitters will not settle down easily.

[email protected]

Mr Mangion is a partner in PKF, an audit and business advisory firm.