Feb 10

Mortgage Funds – still $1???

I’ve had enquiries from numerous advisers wanting to invest their client’s money into mortgage funds. Thanks to the Rudd Government’s deposit guarantee many mortgage fund investors decided to redeem their funds and shift to the more secure bank deposits. Unfortunately for the funds and their remaining investors the level of redemptions were so great, the funds had to suspend all redemptions. Now we are left with the funds drip feeding redemptions to investors and one of the last redemption reports I heard was that investors only received 30% of their requested redemption and will have to wait for the remaining funds when the next window opens.

With the global credit crisis and resulting decline in interest rates, mortgage fund’s income return now looks quite attractive as many funds have a large book of fixed rate mortgages. Whilst they look good, credit spreads are still enormous and whilst these funds aren’t taking on any new borrowers (the redemptions took care of that) they are still rolling their good borrowers at fixed interest rates of at least 9%! Very nice in this environment if you can get it.

What I would like to know is…how can a mortgage fund still price itself at a fixed $1 per unit? The clear lack of liquidity of these unerlying investmetns combined with the massive movement in credit spreads over the last 18 months does not suggest that mortgages price is static. Certainly mortgage backed securities on the over-the-counter market have had a shocking run since the credit crunch began in mid-2007 so to still suggest a $1 price is ludicous.

Clearly the funds do not know how to price these securities with any accuracy, but given the lack of demand for these securities and credit blow-out, if you want to invest at $1 per unit then I suggest you are paying way too much. The interest rate is not anywhere as attractive as it needs to be given the increased liquidity risks and current economic environment.

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