Tight lending and quality mortgages win the day

Tight lending and a focus on quality mortgages gave the top three managers in mortgage funds their award-winning performances in 2001.

Challenger Managed Investments product manager Steven Kyling says there has been a lot of growth in the top end of the mortgage market in the past year.

"Everybody pushed to lend aggressively, but most were directed towards quality investments," he says.

Challenger achieved its top performance by targeting areas other lenders were shying away from, such as small business.

"We looked at areas that the traditional banking industry neglects, such as small commercial business, and then were choosy which deals we did," he says.

"We cherry-picked the deals for results."

While these tactics gave Challenger substantial growth - it is now the largest mortgage funds manager in Australia - margins didn't improve due to competition in the top end of the sector.

"There was some improvement in margins in the smaller end of the market, less than $5 million deals, but there is a lot of competition above that figure and margins have remained static," Kyling says.

Mortgage fund inflows tend to suffer when other sectors such as equities are performing strongly, but Challenger seems to have bucked the trend.

"We found the tech stock crash sent flows back into our mortgage fund," he says.

"In September last year we had $919 million in the fund, but by March this year it had risen to $1.75 billion."

Interest rate changes have sent returns for mortgage funds both up and down in the 12 months.

Challenger returns for the mortgage trust were 5.6 per cent in January 2000, but this had risen to 6.3 per cent by March. As the interest rate cuts start to work through, Kyling believes it won't be long before the returns are back to the 5.6 levels again.

"The Challenger fund is going forward maintaining quality lending and we are building relationships with more commercial mortgage originators," he says.

Improving margins and predicting interest rate rises have been some of the skills Perpetual Investments' fixed interest manager Marion Kraemer has achieved during 2000.

"We had five interest rate rises which all together sent the rate up 125 basis points," she says. "I predicted it would rise 100 basis points, so that wasn't bad."

Kraemer says last year was tough for attracting funds into mortgage trusts with so many other star performers on offer to investors.

"We were the orphan fund for investors and inflows have not been what I would have liked," she says.

"But there has been a big demand for mortgages from investors and that has improved margins."

Perpetual started the year with a 1.25 per cent margin, but that had increased to 1.75 per cent by year-end.

"With the main banks doing less lending, that has been good for margins and good for investors in the fund," she says.

This has also enabled Perpetual to aim at the quality end of the lending market, which has also improved performance for investors.

"It is still a very competitive market, but as interest rates fall, the mortgage fund for investors will come into its own," Kraemer says.

"Mortgage funds are not volatile and they deliver income month after month."

Bendigo Bank subsidiary Sandhurst Trustees has also found it a tough year, but that has given it the opportunity to outperform the sector benchmark, says chief executive Andrew Long.

"There has been a lot of competitiveness in the retail market and in raising mortgages," he says.

"Fortunately our relationship with the Bendigo Bank has given us a large outlet for raising mortgages."

The bank's credit policy has also given Sandhurst access to quality mortgages and Long says there are only have five mortgages with problems at present. This would represent less than 0.5 per cent of the loan book. Sandhurst has a policy of working through the problems to achieve the best outcome.

Sandhurst lends in both commercial and residential market, and due to its rural position it also has some loans in this sector.

It is being fed quality mortgages through the Bendigo Bank's expanding community bank networks throughout the country.

The performance of residential and commercial loans in 2000 performed well, says Long, but the fund is now more weighted towards commercial for better returns.

Mortgage funds

Challenger International

Perpetual Investments

Sandhurst Trustees