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Mar 25

Mortgage Funds…still on the nose to me…but perhaps for different reasons than others

Over the last 12 months I’ve increasingly had inquiries about investing in mortgage funds. During the GFC, pretty much all liquid mortgage funds froze their investor’s funds so access was only available in periodic dribs and drabs and for many this process is still playing out. However, there are some new funds which have raised capital in the last few years, are currently liquid, and with the GFC largely behind us, some investors and advisers are getting curious again.

Whilst I absolutely acknowledge that every investment should be considered in terms of its future return potential (not its past), there is one grating problem mortgage funds have that has bothered me for as long as I can recall…and will always be a sticking point…their pricing.

As fixed income securities, mortgages are very complex. Credit risk is difficult to truly understand because investors don’t have any information on the borrowers; Duration risk is incredibly difficult to work out because loans may have the ability to prepay…so when your variable interest rate goes up, you may think hooray, only to see the principal and interest repaid early for you to miss out on that exposure you thought you had.

Let’s not also forget that mortgages are held over property and there may be other mortgage conditions such as minimum LVR requirements, or other financial conditions…these are risks we don’t really see as investors but surely they are conditions that should result in mortgage prices that will go up and down as these risks become lower or greater.

It is clearly these complexities that make a book of mortgages so difficult to price, so mortgage providers just stick with a $1 unit price and simply pay out the interest. It appears the only time a unit price moves is when there is a default…but even then, I have to admit I’m not so sure…as there appears to be very very few defaults or perhaps the defaults simply impact the income payable.

I could show you the price of numerous large mortgage funds over the last few years, but a flat line priced at $1 doesn’t make for a particularly interesting chart so I have chosen not to expose any names.

Anyway, this complete lack of pricing ability by mortgage product providers is why I will continue to avoid mortgage funds.

In my humble opinion, transparency is a very important investment characteristic and its clearly lacking in these products…but there also appears to be no solution.

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1 comment

  1. Brian Howard

    Thanks for a very interesting article Michael. I often wonder what the real story is re mortgage funds so it is great to see an impartial assessment of the current lay of the land. What you say seems to make a lot of sense to me given that the problems that caused the 2008 debacle have not been fixed, indeed they have become much worse. Common sense has convinced me that there’s another one coming and it will make 2008 look like a walk in the park – by 2016 latest? Could happen next week, who’d know! Cheers, Michael – keep up the great work!

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