Mortgage funds cash up at expense of investors

AUSTRALIAN mortgage trusts are investing an increasing proportion of their funds in cash due to the current down market, meaning investors are being hit with lower than expected returns on top of disproportionate management fees.

A report released by Lonsdale Securities (Lonsec) shows that some mortgage trusts are investing more of their portfolio in cash than their publicly stated maximum, leaving investors unaware of their lower than expected risk exposure.

These funds are also charging the same standard mortgage trust management fee despite the decreased effort required to manage a cash investment.

Lonsec figures to the end of June this year show the ANZ Mortgage Fund Series 2 had the highest weighting of cash, at 47.8 per cent, above its stated maximum of 40 per cent.

The ING Monthly Income Trust was not far behind this figure, holding 47.1 per cent of funds in cash, in excess of its maximum weighting of 40 per cent.

The Perpetual Monthly Income Fund and the Challenger Howard Mortgage Trust also have a relatively high cash allocation of 38.2 per cent and 24.9 per cent respectively.

Lonsec investment analyst Anthony Pesutto says funds management houses are under obligation to remain within the boundaries they identify to investors.

“If they stick to the figures they state in their prospectus, that is within the expectations of the investor,” Pesutto says.

“It is where they state one figure and are found to be above that by a considerable amount that it is a problem,” he says.

The source of the problem according to Lonsec has been a volatile market, causing investors to flock to defensive investments such as cash and mortgage trusts.

“There has definitely been a strong inflow, and in mortgage trusts there is a time lag between receiving the inflow and sourcing appropriate borrowers of funds — so part of it is a timing issue,” Pesutto says.

Lonsec expects the increased cash weighting to come along with a corresponding drop in returns, with figures supplied by Morningstar showing that cash management trusts consistently underperform mortgage trusts by between one and two per cent.

“Mortgages have a higher risk profile and produce a greater yield than cash because of the risk of default from the borrower,” Pesutto says.

Investors are also being forced to pay the same active management fee for being invested in a mortgage trust despite the increased cash weighting.

“In a low interest rate, low inflation environment like we have now, the impact of fees will also be much greater,” he says.

Fund managers traditionally hold a percentage of their mortgage trusts in cash to cope with the inflows and outflows of investors, allowing them to manage funds on a day-to-day basis.

“There is no magic figure for the amount that should be invested in cash, as it depends on things like the type of lending and the strength of the borrower origination process,” Pesutto says.

However Lonsec thinks the important thing is that the cash amount is transparent to investors and that fees reflect the amount of active management actually occurring.

Individual fund managers have been trying to combat the problem of excess cash, with ING closing off its Monthly Income Trust in September and Challenger Howard entering an agreement with Westpac to source more borrowers for its mortgage trust.

AXA Australia has taken the approach of introducing a fixed income asset class within its two main mortgage portfolios.