Even `good' Beasts Can Turn And Bite
The Age
Sunday September 4, 1994
Mortgage trusts cream off less of the investor's funds than do the banks, but don't forget Estate Mortgage and OST. Mark Fenton-Jones reports, the best rate does not necessarily mean top security.
INVESTORS who want the security of quality mortgages to generate a regular income but do not want to pay intermediaries or banks a lot of money should consider mortgage trusts.
When you invest in a mortgage trust, one to 1.5 per cent of your funds goes to the fund manager before getting to the borrower. If you invest in bank deposits or debentures, however, the banks will give you four or five per cent less than the rate a which they lend the money.
Mr Michael Walsh, general manager of the research firm Assirt, said this meant investors were actually paying paying five per cent to the banks. ``This is what makes mortgages more efficient than bank deposits or debentures," he said.
For the year to the end of July, the average return of the 17 mortgage trusts analysed by Assirt was 6.1 per cent compared with 6.5 per cent the year before.
The range of the returns from the past year varied widely, with one fund posting 0.3 per cent while the top performer hit 9.3 per cent.
This financial year, Assirt forecasts an average return of 4.5 per cent, although in the medium to long term this is expected to reach up to six per cent.
Mortgage trusts are complex beasts that can savage you if you buy because of return alone. As Estate Mortgage and OST investors discovered, the best rate does not necessarily mean good security.
``The game is a lot more than rates," Mr Walsh said. ``You do need to understand the mortgage portfolio and the way its managed. It's not wise for an investor to go into a mortgage trusts without getting access to that understanding."
Mortgage trusts are difficult to analyse because the underlying assets are not valued on the market. These assets will include cash and residential, commercial, retail and industrial properties. The mortgages securing them can be either fixed or variable.
It is the fund manager's job to get the right mix to take advantage of market conditions. For example, if variable rates move up, a fund manager will want to have enough cash or turnover of mortgages to move investor funds into higher-earning mortgages.
Financial planners and advisers buy reports published by research houses such as Assirt, IPAC Securities and Purvis van Eyk, which regularly assess the risks and returns of funds. Mr Walsh noted that very few advisers were recommending Estate Mortgage.
Estate Mortgage collapsed in 1990 owing 55,000 unit-holders $600 million invested in so-called first-mortgage securities when, in fact, many were high-risk property construction developments.
When the property market fell, unit-holders were unable to recover their original capital because the value of the properties backing the mortgages collapsed in spectacular fashion.
The main areas of risk with mortgage trusts are interest rate, liquidity and capital risk. Most people who invest in mortgage funds for the long-term income stream will experience a lag in their income as it follows the upward movement in interest rates. That lag will be the time it takes the mortgage lender to readjust the portfolio or change interest rates in the rising interest-rate environment.
``People seeking higher alternatives at the moment should also anticipate that the mortgage trust will gradually increase its distribution," Mr Walsh said.
Interest rates have not reached the heights of four years ago, but if they do this would put a greater financial burden on borrowers and increase the risk of default.
``Any assets in default have the capacity to erode the value to unit- holders," said Mr James Purvis, a director of Purvis, van Eyk and Company.
Assirt says the risk to capital is not a big consideration now because, with interest rates rising, the prospect of a fall in property values is low.
Liquidity risk is the ability of the trust to manage its cash flow, in particular to provide for redemption. Maturing mortgages generate liquidity, provided the borrower is in a position to repay or refinance. This relates closely to the health of both the economy and the property market.
© 1994 The Age