By Geoff Rowles, Managing Director of Principled Mortgage Investments Ltd
There are a number of different “Mortgage Funds”. Debenture companies, registered and unregistered managed investment schemes, wholesale funds and banks can all call for investors to “put money into mortgages”. For most investors, wholesale funds, hedge funds and banks may provide investors with a link to mortgages (as many found in the US Sub-prime crisis), however that link will not be properly disclosed as the link is indirect.
There are three main types of “pure” mortgage investments in Australia at the present time for retail investors. These are Debenture Funds, Contributory Managed Funds and Pooled Managed Funds.
Debenture companies are companies that have applied to the Australian Securities & Investments Commission (ASIC) to register a prospectus that allows then to borrow money directly from the retail public instead of borrowing the money from a bank or other professional lender. What they can do with the money is determined by what they say they are going to do with it in the prospectus. The key issue here is that buying a debenture is actually a loan to the company.
For mortgage debentures, the prospectus will typically set out a range of lending parameters and criteria used to assess loans. ASIC has also introduced Regulatory Guide 69: Debentures – Improving Disclosure for Retail Investors, which requires the debenture issuer to disclose whether or not they meet 8 specific benchmarks. If they do not meet them, the issuer needs to say why they have not met them. Interestingly, ASIC does not require the benchmarks to be met as a minimum standard.
Managed Investment Schemes
Managed investment schemes are an arrangement where investors invest in money managed as a trust by the company that operates the business. This is important because you own your share of the mortgage assets of the scheme, whereas the debenture issuer owns the mortgage assets. If these schemes are registered, they will be regulated by ASIC, and are required to provide a Product Disclosure Statement (PDS) rather than a prospectus. If they are unregistered or are supervised by industry bodies, you may be on your own.
The PDS of a registered managed investment scheme will set out the benefits and risks of investing in the scheme, as well as the criteria used to assess loans. ASIC introduced Regulatory Guide 45: Mortgage Schemes – Improving Disclosure for Retail Investors, which requires the issuer to disclose whether or not they meet 8 different benchmarks. Again, if they do not meet them, the issuer needs to say why they have not met them.
Managed funds may be set up as either Contributory funds or Pooled funds. Contributory funds (such as the Select Mortgages Option™) allow investors to receive detailed information about specific mortgage investments and then determine whether or not your money will be contributed to that specific mortgage. The type of information you receive should include the term of the loan, the interest rate and when income will be paid to you, the security for the loan and its value, and your withdrawal rights.
Benefits of contributory mortgages include having control over which mortgages your money will go into and having greater levels of information disclosed to you about each one. Risks include being exposed to individual borrowers rather than spread over many loans. Remember you should read the PDS for each fund to determine its own particular benefits and risks.
Pooled funds (such as the Common Mortgages Option™ and the Prime Mortgages Option™) do not give investors specific details of the mortgages that the fund invests in, but will define the characteristics of the qualifying mortgages. Investors pool their money with other investors in these funds and have a share of all the mortgages and other assets of the fund.
Benefits of pooled funds include risk diversification – investors’ money is spread over a number of mortgages and exposure to any one borrower is lowered. Risks include liquidity management and portfolio diversity. Again, you should read the PDS for each fund to determine its own particular benefits and risks.
ASIC has provided commentary on these types of funds (here as well). ASIC has also produced a booklet that explains its eight benchmarks for Managed Investment Schemes and a booklet on unlisted debenture funds.
Investors should ensure they consider some key principles when making a choice of which type of investment to choose. As always, we recommend you obtain independent advice from a financial advisor licenced by ASIC to provide that advice and who has experience in dealing with these types of investments. A financial planner who only deals with shares will not be able to provide you with assistance in these products.