REIT Sector Hedge Funds Under new scrutiny: the Commonwealth bank. As hedge funds pile into the Australian listed property trust sector following a proposal by Commonwealth Bank to exit its $20 billion property trust platform, the spotlight has turned on three relatively unknown independent non-executive directors. The directors, Nancy Milne, James Kropp and Richard Haddock, are on the board of Commonwealth Managed Investments Limited (CMIL), which is a subsidiary of the bank and is the responsible entity of shopping centre group CFS Retail Property Trust Group (CFX) and Commonwealth Property Office Fund (CPA), which owns office towers and developments. When CBA approached the responsible entity with proposals to internalise the management of the listed funds it immediately established a subcommittee of three independent directors to consider the proposal. In a statement the CMIL board said it could not guarantee that the proposal would proceed and that approval from unit holders would be required. This puts the trio of directors squarely in the hot seat to make a decision that could reshape the Australian listed REIT sector. On the one hand, as directors on the board of the responsible entity they must act in the best interests of all its unit holders. "Underpinning our activities is to put the rights and interests of [CPA and CFX's] investors first in our decisions," the annual reports say. In its board charter CMIL also makes it clear "that in discharging its duties to the unit holders that the interests of unit holders may be different to those of the bank and that it has a duty to act in the best interests of unit holders including, where necessary, situations where those interests may conflict with the interests of the bank." It makes this clear because the directors of CMIL are appointed by CBA's board performance and renewal committee, their fees are ultimately paid for by CBA, and CBA ultimately has the power to fire them. In addition, two of the three directors, Kropp and Milne, sit on other external CBA entity boards. The external management/responsible entity structure has been fiercely debated over the years by corporate governance experts. A key concern is independence: the boards are owned by the main company, the directors aren't elected by unit holders and there is no requirement to hold AGMs. In regard to CMIL it does hold annual meetings with its investors and it has said that if the proposals progress to the next round, it would seek independent advice, including an independent expert. The board would then make recommendations on CFX and CPA. At the end of the day it is up to investors to vote on the proposal. While unit holders ultimately have the power to sack the responsible entity, it isn't easy as unit holders have to convene the meeting. It is also difficult to make a takeover bid for externally managed funds as most have a poison pill loaded into them, which makes it difficult to remove the manager and take control. It is a rare occurrence to have a willing seller of management rights and an ownership stake in a good-quality Australian portfolio, in an environment awash with institutional capital. So when CBA announced it wanted out of the trusts, it was like putting up for sale sign. Dexus Property Group moved swiftly to take a 14.9 per cent stake in CPA, raising speculation about whether it would make a full takeover or another fund such as Investa would make its move. Despite most trusts successfully completing recapitalisations a few years ago after going on a debt binge in the years leading up to the global financial crisis, there hasn't been much corporate activity in the REIT sector. This is expected to open the floodgates on corporate activity. For instance, it wouldn't surprise if GPT has a look at CPA given it has the balance sheet and office fund capacity and recently stated a willingness to launch a suburban office fund. As one analyst said, "Mirvac is a dark horse, but if there is enough redevelopment opportunity in CPA, then it could be appealing, plus its partner Keppel REIT wants more Australian office exposure." CFX is a much larger bite than CPA but it is also expected to be a takeover target. CFS has a unique portfolio of assets. So any interest is likely to come from an overseas buyer, such as Simon Property. If these go, it is likely to have a domino effect on the rest of the sector as others try to get bigger to attract investors. It has been a long time coming. After the global financial crisis and the recapitalisations, speculation was rife that takeover activity would resume but corporate activity was stifled by most of the REITs trading at big discounts to their net tangible assets. To this end they launched share buybacks to close the gap. When Dexus bought a 14.9 per cent stake in CPA it was seen in the sector as a watershed moment. It prompted interest in the sector by hedge funds, with short selling in the sector rising in the past few days. Hedge funds are punting that Dexus will acquire CPA outright with one analyst suggesting in a note to clients it might do this via the establishment of a new wholesale office fund. While semantics about the treatment of assets from the broader balance sheet to a wholesale fund may remain as a moot point (particularly around NTA and perceived conflicts), I keep asking myself why my initial reaction to this was a 'seat at the table' (i.e. second place) as desired outcome from a starting position? Indeed.