When It Comes To The Crunch, Well-managed Funds Will Survive
Sydney Morning Herald
Saturday November 1, 2008
The Government's bank deposit guarantee has created a run on mortgage funds as investors switch to the guaranteed banks' accounts. That has prompted mortgage fund managers to freeze withdrawals. While that is a problems for retiree investors who need the money for expenses that cannot be deferred, their capital is safe.
Standard & Poor's rates 17 mortgage funds, accounting for 80 per cent of the funds under management in the sector. In a report this week, S&P said the quality of the assets and the management of the funds "have not altered materially". But there has been an increase in the number of players in the property lending business, and some are higher-yielding, but also much riskier, investment propositions. While property values were rising and the economy was growing strongly, these risks receded into the background as the lure of big returns held sway. Now the worm has turned and many thousands of retiree investors are about to become considerably poorer. Retirees have long been attracted to mortgage funds and the perceived safety of bricks and mortar. They receive steady income each month while their unit prices stay at $1. But the conservatively managed mortgage funds run by the big managers have been paying relatively poor returns in recent years, after their hefty fees have been taken out. Investors have been able to get higher returns with no risk from online savings accounts backed by big institutions. Research houses have been less enthusiastic about mortgage funds in recent years, but they have maintained that some still have a place in a conservative investor's portfolio. The clients of the researchers are financial planners, and the researchers mostly limit their research to those investments, such as mortgage funds, that pay commissions. Although mortgage funds have frozen withdrawals, or have moved to quarterly withdrawals, they continue to make monthly distributions to investors. Those investors in the big-brand mortgage funds run by the likes of Perpetual, AXA and Australian Unity will come through the market turmoil with their capital intact. These big brand funds tend to limit their lending to residential property developers to 10 per cent of the loan book. Their loan-to-valuation ratios are also low. But a group of much riskier mortgage funds has been launched in recent years. Some of these riskier, higher-yielding funds have been linking with finance brokers who organise loans with local residential property developers in exchange for commissions and other kickbacks. There have been too many funds chasing too few loans of sufficient quality, and the banks have been lending more to the better-quality borrowers. Those investors in some these riskier mortgage funds, some of which closed to withdrawals this year, will probably not escape without taking a hit to their capital. However, the capital losses should be limited as the riskier funds are generally well diversified.The riskiest are those property financiers who lend money to residential property developers. They advertise debentures direct to the public. These loans are not like the mortgages that home buyers take out, whereby the principal and interest are paid back gradually each month. Developers generally do not pay interest on the loans. On a particular day, two or three years down the track, the developer repays the principal, the interest, the interest on the interest, and fees and commissions to the mortgage fund. Since 2003 some residential property markets, especially in western Sydney, have soured and the level of bad debts has increased. Many of the players, including Westpoint, Fincorp, Australian Capital Reserve and Bridgecorp, have collapsed. They ran advertising suggesting investors' capital was secure, raised funds through debentures or notes, then used the money to fund property projects, often their own. These were the largest, but many more have fallen by the wayside, including Elderslie Finance Corporation this year. The collapses since 2006 have left more than 30,000 investors with losses of more than $1.5 billion. Many were retirees who lost their life savings. There are a further $2.5 billion and 50,000 investors in more than two dozen property financiers whose debentures are unrated by credit rating agencies. Many of these property financiers are regionally based, with a narrow geographical spread of mortgages and without institutional backing if something goes wrong. Property financiers were finding it harder to attract investors, anyway, because of the negative publicity about the earlier failures. And the Australian Securities and Investments Commission has forced them to be much more explicit in offer documents and advertising about the risks. The financiers rely on investors rolling over their investments when the fixed term ends. With the market turmoil, investors were already switching into term deposits with the banks. The bank guarantee is exacerbating the trend. Investors in the better managed property financiers will come through unscathed, but a shake-out of these smaller players is on the cards.
© 2008 Sydney Morning Herald
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