What is a mortgage fund?

A fund that invests in loans and passes on the rate of interest as a return. 

How does it work?

Imagine yourself as an investor with spare cash. You could lend it to someone wanting to buy a home and charge an interest rate. 

What rates of return are they paying?

At the time of writing, a well-diversified fund with a portfolio of loans on predominantly built home might pay around 5.3% (13/10/2022). The construction loan version of this might pay around an extra 1.5-2% for the added risk. A single property loan risk might fetch an extra 2% for no diversification. 

Which segment of asset allocation do they sit?

• In the traditional asset allocation split between Cash/Fixed Interest/Property/Shares, they sit in the higher risk end of Fixed Interest. Some could argue this sits in Alternative assets instead. 

• Fixed interest investments typically include Government or Corporate debt and can have capital volatility due to being traded on the secondary market. However you can avoid secondary market capital volatility by investing in unlisted debt, one of which are mortgage investments described here.

Are there lock in terms?

You might find lock in periods anywhere from 6 months to 2 years or more. You might get monthly liquidity through a wrap account with an extra 0.5% interest rate.

What risks are there to manage with the borrower?

• Borrower with a proven ability to repay.

• Credit manager with ability to manage defaults and arrears on those having trouble repaying.

• Not lending too much – eg lend 60% of the value of the property instead of 90%.

• Have first mortgage against the property so you have first priority over selling if you need to recover money. Second mortgages or mezzanine are higher risk and should attract a higher interest rate.

What should you find out about the fund/investment manager?

• How they address the above bullet points – risks to manage with the borrower.

• How big the fund is and how long they have been in business.

• Have they have missed a payment or been frozen since inception. Have they survived major market crashes like the GFC.

• How many loans they manage and how much this is spread over Australia – I prefer more diversification even if it means lower interest rate.

• Do they have a Product Disclosure Statement or are they for Sophisticated/Wholesale investors only that require an accountants certificate (for those with more money).

• Could they send you independent research house rating reports on them, like Morningstar, Lonsec, Zenith, SQM, etc.

• For construction loans, do they release credit all at once, or bits at a time. 

• What are their loan arrears statistics at the moment.

• What are their lock in terms – is it a few months, 12 months or 2 years? Are they offered through a Wrap provider with more generous liquidity terms or bonus interest?

Further questions

• Feel free to ask your financial adviser/planner about this, or myself.