Mortgage Funds

What is a mortgage fund?

A mortgage fund is a unit trust operated by a fund manager which invests in mortgages on properties. The fund raises money by selling units in the trust and that money is lent out as mortgage loans to a range of borrowers which buy and/or develop properties. Some funds might use the money to invest in other mortgage funds.

As an investor you are acting in a role similar to a bank. You receive a regular income stream (distributions) from the manager that is secured by mortgages over the properties.

There are two types of mortgage funds:

Pooled mortgage fund

  • Investors share in all mortgages/investments in the ‘pool’.
  • All investors share the income and spread the risks of all mortgages/investments.
  • Some funds promote the ability of investors to withdraw money at short notice but, in reality, it is always subject to the amount of cash the fund is holding.

Contributory mortgage fund

  • You or the fund manager specify which mortgages to invest in. These might be for single properties.
  • Your mortgage might pay a different income than other mortgages in the fund.
  • Your risk depends on the quality of the borrower.
  • For most funds, you can only withdraw your money when your mortgage(s) mature.

Mortgage funds can provide strong steady returns when managed well. But there are a number of risks. Some of those risks are outlined below and investors should read the product disclosure statements for a full description of the risks in a particular fund.

Diversity – Ideally a fund should not invest in too many mortgages in the one area, or the same types of property (e.g. industrial), or to the same type of borrower (e.g. developers).

Liquidity – An investment in a mortgage fund should be considered a longer term investment as the fund is not usually able to terminate a property mortgage on short notice. That said, well-managed funds retain some cash to meet liquidity and orderly redemption requirements. Some funds may only allow redemptions when new investors subscribe for units. Each fund document should detail their policies in this regard.

Disclosures important to investors

Investors should assess: how much the fund can borrow and how much it has actually borrowed; how much is due to be repaid in the next 12 months; does the fund have the cash flow to repay/refinance the loans; has the fund managed its risks by spreading the money it lends and invests between different loans, borrowers and investments.

Fund managers are required to disclose: the fund’s assets (including number and types of loans; largest loans, defaults or late payments; upcoming loan commitments and any security taken over loans; the fund’s policy for lending money (including how much it will lend to each borrower and rollover terms); the fund’s policy on investing in other mortgage funds; and, if those investments are listed/unlisted and meet required benchmarks.

Investors should also understand: how are the mortgage fund’s underlying assets are valued; and, exactly how much a mortgage fund’s underlying assets are worth (that is, accurate valuations of the mortgage security).  It helps to know: how accurate these valuations are likely to be; how and how frequently they are done; and, who does them. Ideally a panel of independent valuers is retained to provide a consistent methodology.

Like any investment, those considering mortgage funds should educate themselves about the sector and the risks that entail.