ash flow investing is a means of generating passive income from the very first day of committing the investment capital, unlike equity (if no dividend) or other type of asset investment that relies on future capital gain. In saying that cash flow investing doesn’t deliver multiples return as promised by venture capital or private equity deals. Credit fund or mortgage fund, is an asset class or investment type common for cash flow investors, or yield seeking investors. A mortgage fund put simply is a fund that lends to borrowers, with interest income as a form of return to investors of the mortgage fund.
Disclosure: I write this as a member of the fund manager of our own mortgage fund - One Lending Fund (www.n1funds.com.au).
Benefits of investing in a mortgage fund:
1. Attractive and regular income
2. Clear exit timeframe if fixed term investment
3. Safe underlying asset - applicable if backed by real estate
What are the cons? All investments come with risks. It’s how investors and fund managers mitigate those risks that matters. Below I have outlined a checklist to complement investors decision making process when selecting a mortgage fund to invest.
Mortgage Fund Investments checklist:
1. Beware of abnormally high returns
I don’t believe a mortgage fund with abnormally high return is sustainable. Simple maths, the higher the return promised to investors, the higher the rate it has to be made in loans. And if there are borrowers willing to take on such high cost loans, they must be desperate, most often means low quality loans.
2. Look out for net returns not gross
Read the fund Information Memorandum (or PDS) carefully, don’t just believe the headline return rate. I have seen an advertised gross return 12%pa+ that comes with an asterisk (*), net of all fees and charges you would have shaved a few percentages off the actual return. Disclosure is important, but expectation is another matter.
3. Check liquidity and redemptions policy
Is the fund liquid? Read the next point to learn how to gauge liquidity. What is the redemptions policy? Putting in a "Request to redeem" doesn’t mean you’ll get your money back immediately. It’s no joke and it’s normal to see up to 90 days redemption period. This won’t be applicable and not a concern if it’s a fixed lock in investment period (read below #9). I am proud to say our redemption is always spot on the day of maturity.
4. Diversified portfolio is key and average loan size
Diversified portfolio brings liquidity to the fund. A diversified portfolio needs to have a fund scale sufficient enough to spread their loans across as many borrowers as possible. In the worst case scenario of a default loan, diversified portfolio provids cushion against major losses. In simple terms, one bad apple doesn’t spoil the whole loan book. If it’s a $10mil fund invested into a $8mil development project, it’s too much of a concentration risks. In general, the lower the average loan size, in relative to size of fund is a good indicator of concentration risks.
5. Nature of loans
The types of loans are very important, that’s when a strong credit policy and an experienced credit team plays a critical role. Well defined policy such as purpose of loan, exit strategy of loan, type of asset accepted, locations of asset, leverage ratio, etc. all plays a part in the overall risks assessment of a loan. Check out the background of the investment manager teams. Do they have a strong credit team? Do they have compliance team to overlook the process? Do they have a board of directors overseeing the management to make sure rules are being followed? Another thing to look out for, are they too many construction loans or residual stock loans in the portfolio? Personal opinion, I do think these loans are generally higher in risks, but can be mitigated. It’s just not our risk appetite but they are people doing great in this.
6. Investment Exit Strategy and/or Timeframe
We can’t stress enough the importance of a clear definite exit strategy and/or timeframe. If you’re investing into a contributory fund, most likely you’ll rely on an exit strategy, with conditions such as successful sale of built houses or apartments. If you invest into a pooled fund, with a definite lock in period, then check the redemption policy. Email me email@example.com if you want to find out more about contributory vs pooled fund.
7. Investment Managers quality
Look out for the track record of the investment managers. Real track record should be verifiable, an audited statement or financials although not a must but always nice to have. Investment managers who can source abundant deal flows, usually enjoy the luxury of cherry-picking the quality loans, a huge value to fund investors. Investment manager of equity or properties doesn’t automatically qualify them for credit (lending) experience. In most instances, “lending against a property” vs “buying a property” is a totally different practice. It’s not uncommon for fund managers to have bias opinion when assessing deals in the eyes of a buyer instead of a lender.
The above of course not meant to constitute investment advice, please email firstname.lastname@example.org if you wish to discuss more.
Disclaimer: N1 Loans Pty Ltd ACL 473016, N1 Venture Pty Ltd AFSL 477879