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High Livez -€“ we road test a high-yield fund

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The search for higher yield is prompting many investors to consider investing in residential mortgages.

The mortgage funds industry was shaken in the wake of the global financial crisis (GFC), which resulted in some funds being temporarily frozen. However, the attraction of a regular ‘high’ income stream is again proving popular with investors and some newer style investment structures have come onto the market.

One new entrant in this space is the Firstmac High Livez fund. High Livez is technically not a mortgage fund, as it invests in mortgage securities rather than directly in individual mortgages. But as the underlying assets are the same, it is sometimes grouped in this category from an asset allocation point of view.

Who is Firstmac?

If you’re a Brisbane Broncos supporter, you will have probably noticed their sponsorship on the jersey. If you don’t follow rugby league, the brief ‘about us’ version is that Firstmac is an Australian-owned company whose core business is to issue and service home loans. They manage $5 billion in residential mortgages and have written about 70,000 mortgages in the past decade, distributing them through mortgage brokers and more recently, directly under the Firstmac brand and online subsidiary company, loans.com.au. They fund their mortgages by issuing Residential Mortgage Backed Securities (RMBS).

What are Residential Mortgage Backed Securities?

RMBS are asset-backed securities that are secured by a pool of residential mortgages. Typically purchased by institutional investors (including the Australian Office of Financial Management as a government initiative to give a hand to second-tier lenders and promote competition in the mortgage market), they are tradeable notes and issued in transactions of around $300 million to $500 million, secured by around 2,000 individual mortgages.

Each transaction is broken into two or three tranches, with different tranches having different underlying credit qualities. The tranches are subordinated to each other, meaning that if an individual mortgagor defaults, after which there is a loss on the sale of the residential property, the claim on the mortgage insurer or the retained margin, then the loss is recouped from the principal of the lowest ranking tranche. Accordingly, the different tranches earn different interest margins.

Firstmac High Livez

High Livez is an unlisted, open-ended unit trust with an objective to provide stable monthly income returns by investing in a diversified portfolio of asset-backed securities and short-term money market securities. It aims to outperform the Reserve Bank of Australia’s benchmark cash rate by 3 per cent. The key details are as follows:




In relation to asset quality, the trust will limit investments in RMBS to a minimum risk assessment of ‘Category 3’ (which is defines as strong), and for money market investments, ‘Category 2’ (defined as very strong).  It uses a five-point scale, with ‘1’ being the highest at extremely strong and ‘5’ meaning speculative. The point to note here is that in relation to RMBS, the trust’s investments are likely to be notes that are subordinated to more senior tranches.

Performance

Performance of the trust has been strong and it has outperformed its benchmark by around 0.6 per cent pa. Returns (net of fees) to the end of October are as follows:



Strengths

The performance of High Livez has been strong, outperforming its benchmark and peers. Management fees are low at 0.60 per cent pa (including expenses), there are no withdrawal or other fees, and no buy/sell spread. Also, it seems to meet the ‘purpose test’ for a unitised investment as it facilitates access for retail investors to the RMBS market – a market that is usually only accessible to institutional investors.

Perhaps more importantly, the manager (Firstmac) has many years of experience in the residential mortgage market. On the RMBS programmes it manages (where Firstmac provides the mortgages), investors have not experienced any capital losses.

Weaknesses

The fund was only initiated fairly recently, and while growing, it’s small at $12.3 million as at the end of October. There is a diverse pool of underlying mortgages supporting the RMBS, however the geographic spread is biased towards Queensland residential property at about 40 per cent.

Further, the fund is mainly invested in Firstmac issued RMBS. This raises a potential conflict of interest between Firstmac’s role as the manager of the fund, and Firstmac’s commercial interest as an issuer of RMBS. There are procedures in place to manage this conflict (for example, to ensure fair market pricing, any investment in an initial tranche of a Firstmac RMBS can’t exceed 75 per cent of the total value of that tranche), however the personnel on both sides are largely the same. This has obvious advantages and disadvantages.

Bottom line

The Firstmac High Livez fund is innovative and offers the potential of a high return. That said, this isn’t a place to park your cash. As the product disclosure statement (PDS) points out, the investment timeframe is medium term at three to five years. High Livez may suit an SMSF or investor who wants a regular income stream, is prepared to take some higher risk and doesn’t need access to their capital.

In an asset allocation sense, categorise this as ‘diversified fixed income’ and weight accordingly. And of course, always read the PDS, which is available at: https://www.firstmac.com.au/Documents/High-Livez-PDS.pdf.

Important information: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Anyone should consider the appropriateness of the information in regards to their circumstances.

Published on: Friday, December 07, 2012

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