Mortgage funds on the way back?

An easing-off of term deposit rates, reduced redemption pressure and a shift to fixed-term redemptions only could make 2012 an improved year for the battered mortgage fund sector, according to property researchers SQM.

SQM recently handed out its first-ever four-star rating to managers La Trobe, which SQM director Louis Christopher said was one of the few funds to "fly though" the troubles of 2008 due to its limited redemption structure as well as its management team and relatively low gearing.

A more limited redemption structure and fixed-term redemption periods are the future for the sector, he said.

The daily liquidity offered by many funds - plenty of which disappeared following the liquidity squeeze associated with the global financial crisis - was unlikely to ever return, he said.

SQM is favourable to those funds whose redemptions are in fixed terms and where it was clear the manager was in control of the budget, he said.

Christopher said financial planners who have clients in cash and are looking for some extra yield - but don't want too much volatility or exposure to direct real estate - would be candidates for an allocation to mortgage funds, which could provide relatively stable returns around 7 to 8 per cent.

"We believed this sector had a brighter future, and we think that is now coming to hand. It just boils down to the individual product provider," Christopher said.

Australian Unity Investments head of mortgages Roy Prasad said the redemption demand from retail investors was continuing to decline, although not as fast as Australian Unity would prefer.

But investors who had participated in every redemption opportunity from mid-2008 would now be fully redeemed, suggesting that most of those still invested wanted to be there.

Prasad said 2012 would be a significant year for mortgage funds after three years of seeing the sector contract.

With redemption offers now more closely matched to underlying liquidity, it was a case of trying to re-educate the financial adviser community, and going through the process with researchers to get them to move from a holding pattern back to investment grade.

Prasad said it was probably the right point in the cycle now, with term deposit rates coming off and likely to slip further. There would soon come a tipping point where mortgage funds were consistently outperforming term deposits, he said.

However Morningstar co-head of fund research Tim Murphy is far less optimistic for the sector.

"Demand [for mortgage funds] in the adviser space is zero," he said. "You can still get 6 per cent in a term deposit."

While in theory the present is a better time for mortgage funds than the recent past, and the limited redemption structure would also help, the returns for key mortgage funds in the last few years had been less than term deposits and with less liquidity, Murphy said.

"The certainty of a term deposit versus the uncertainty and illiquidity of mortgage funds makes it very unattractive for advisers. Combined with the behavioural effects of the experience from 2008, there is not much appetite from advisers we deal with for that type of fund."