What should Investors look for in a Mortgage Fund?

Disclaimer: We hate disclaimers, but they are a requirement.  This article is of a general nature only and does not consider your individual circumstances (obviously).  You should seek the advice of a qualified and licensed financial advisor before you invest in any investment.  Seriously, you hear this all the time but it’s true -unless you are gambling, in which case you are entitled to act without regard for the best outcomes of your investment.

There is no doubt the investment markets post-GFC and the events that led to the financial markets changing so rapidly will become a study topic for investment and finance students, banking and economics students and regulators for many years to come.  It has also proven to be a watershed period for the Mortgage Funds industry.

The questions that investors should consider now are:

  • Should I still consider investing in Mortgage Funds?
  • If so, how do I identify a well run Mortgage Fund and how do I assess the fund on an ongoing basis.

Are Mortgage Funds still a good investment?

There are various reports about what the size of the Mortgage Fund industry in Australia is.  ASIC reported in 2008 that the unlisted debenture funds have $2.67 billion1 while the unlisted managed funds industry has $42 billion2.  While the funds under management has grown, the industry has been slowly consolidating.
All investments, be it equities or propoerty or bonds have risk. Mortgage investments can, when selected well, be a form of investment that allows investors to manage the amount of risk they want to accept and in many cases fix the return they will get for that risk.

Most of the Mortgage Funds that froze redemptions in 2007 to 2009 continued to pay the monthly or quarterly income from their investments, but they were unable to pay redemption requests.  This highlights that mortgage funds will typically be subject to “liquidity risk” – the risk is that they will have assets (that generate income) but will not be able to convert them into cash when you want to withdraw your funds.

Yet there were a number of Mortgage Funds that failed.  These funds were typically pooled, were typically investing in higher risk assets, and were typically offering significantly higher rates to attract people to that risk.

How do I identify good Mortgage Funds?

Mortgage Funds have for some time been required to make certain disclosures that can help you to work out if a Mortgage Fund is going to be suitable to your risk appetite.  Here is a five part process that may assist investors.

The first process to undertake when considering a Mortgage Fund is to consider the type of fund you would like to invest in.  Further information regarding this choice can be found in this article.

The second process for an investor should be to examine a couple of key issues within the rules of the fund so that you can understand the level of “structural risk”, meaning the risk that is present because of the way the fund is set up to work.  A couple of these issues are:

1. Scheme Borrowings
Some managed funds and debenture funds have rules that allow them to borrow money from a bank and use your investment as security for that borrowing.  This may be used to allow the fund to repay investors, pay distributions, settle new loans or even pay fees to the issuer.

Typically, the bank will have an agreement where the bank holds priority in receiving its money back from the assets of the company or scheme before investors.  You have to wonder why this would be a good idea from the investors point of view – the assets of the company or scheme have been acquired with your money, the bank provides additional amounts and gets the right to have its money back before you do.  In this case, the investor is bearing the risk while the issuer (fund manager) gets the benefit.

You should consider a fund that does not allow loans to be secured against the assets of the company or scheme in preference to your money.  This is required to be disclosed under the  benchmarks ASIC has introduced for both debenture funds and managed funds3.

2. Related Party Transactions
Many schemes and debenture funds are allowed to lend your money to themselves or related parties.  While for a debenture fund this may make sense (see above where I discuss this is a loan to the company) because a loan to the issuer is much the same as a loan to a related party, it does matter what they do with it.  The prospectus will say what the issuer is allowed to do, but it may not say what the related party is allowed to do.  You may end up investing in a mortgage to a related company that is using the funds to build a highly speculative development site, together with taking fees throughout the transaction.

For a managed investment scheme, lending to related parties makes even less sense.  By investing in a scheme that is allowed to lend to related parties, you have effectively turned your investment into a loan to the fund manager, rather than the fund manager acting as a manager of funds!

The ASIC benchmarks also require the issuer of debentures or managed investment scheme products to advise you of the ability to undertake related party transactions.

The third process an investor should undertake is to consider who and how long the fund manager has been providing the mortgage investment services.  There are many funds that have been providing mortgage investments for many years, and their managers are experienced in this industry.  There are also other funds that have been set up recently and may not necessarily have the experience or skills to provide what investors require.  Principled Mortgages™ experience is described here.

The fourth process should be to consider in detail the material in the Product Disclosure Statement (“PDS”) or Prospectus.  A PDS is required to have information required by the Corporations Act and various regulatory Guides issued by ASIC that help an investor understand the benefits, risks and rights of investors when investing in a product.  Pay particular attention to the disclosures made under Regulatory Guide 45 or Regulatory Guide 69, as these have been introduced specifically to help investors understand the manner in which the fund is run.

The fifth process is to get advice.  I suggest you seek independent financial advice after you have considered the material in the prospectus or PDS that ensures your specific needs are considered, rather than just receiving general advice.  Remember to ensure the advisor is licenced by ASIC (you can check this on ASIC’s website) and that they have experience in this form of investment.  It is pointless going to a financial advisor that specialises in shares and ask them about mortgage investments.  You wouldn’t go to a lawyer for advice about how to install your kitchen (although they would probably give you advice …)



  1. ASIC, “Report 127 – Debentures – Improving disclosures for retail investors”, April 2008
  2. ASIC, “Consultation Paper 99 – Mortgage Schemes – Improving disclosure for retail investors”, July 2008
  3. ASIC, “Regulatory Guide 45 – Mortgage Schemes – Improving disclosure for retail investors”, September 2008 and ASIC, “Regulatory Guide 69 – Debentures – Improving disclosure for retail investors”, October 2007