Mortgage Trust Explained - Free Financial Advice for Australians

Why things are Freezing in Spring!
By Venn Williams

Over the past few weeks there has been a lot of talk in the news about a freeze on redemptions from mortgage funds. Given that there's around $20 billion in mortgage funds in Australia terms like 'freeze' are pretty scary so we wanted to talk through what a mortgage fund is and what the freeze actually means.

So what is a mortgage fund? A mortgage fund is a managed fund that takes investors' money and uses it to make mortgage loans, that is it lends money to people so they can buy retail, commercial, industrial or residential property. This means that the properties these people buy with the money they borrow from the fund are essentially owned by the investors in the mortgage fund.

All well and good, but how do investors make money off these funds? Quite simply, investors receive the interest payments on those mortgages, after the manager deducts fees and expenses, of course.

Mortgage funds are considered quite conservative investments but do carry more risk than cash.

Ok, so why were mortgage funds frozen?

A few weeks ago the Federal Government announced a guarantee on bank, building society and credit union deposits. As mortgage funds are market-linked vehicles rather than cash they are not included under the Government's guarantee. This meant that there was a flood of redemptions from mortgage funds as people sought the safety of Government-guaranteed accounts.

The redemption levels were so high that the mortgage funds felt that their cash positions would not be sufficient to meet future redemptions in a timely manner. Since underlying mortgages are specific agreements between the lender and the borrower, they cannot be actively traded on a public market. The mortgage funds therefore believed redemptions should be frozen in order to protect the underlying assets of the fund. Since these assets are effectively owned by the investors, the managers of the mortgage funds were acting to protect the interests of remaining investors. Unfortunately, this involved denying access to these remaining investors' capital.

So the funds have been frozen, but are they safe?

Researchers say investors who invested in mortgage funds through institutions should have no cause for concern and their capital will be safe. The general manager of research at Lonsec, Grant Kennaway, believes: "The brand-name ones will be alright. The Perpetuals, the Australian Unitys and AXAs have been around for years and I am not expecting any problems with the capital or income."

So where to from here with mortgage funds? Should people sell up and put the cash in a Government-backed account?

No. Like shares, this is the worst time to sell because it means your paper loss will become an actual loss.

The two important things to remember about mortgage funds at the moment are that investors are still receiving distributions (that is, income returns), and that regular income streams, such as pensions, continue to be paid.

At this stage investors will have the chance to redeem funds every quarter. If investors are suffering hardship and really need to access their funds to pay medical expenses, stop their homes being re-possessed etc, they can apply to ASIC to have their capital released.

So that's the mortgage fund freeze in a nutshell. Here's to warmer days!

Mortgage Trusts Explained

Mortgage Trusts Explained

Ok, so why were mortgage funds frozen?

So the funds have been frozen, but are they safe?

Article originally published in Halogen Connect Ezine - November 2008.

Venn Williams - Halogen Pty Ltd