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I am hot! And I am bothered!


As interest in mortgage funds looks to grow, are investors considering the risk of illiquidity and the importance of time horizon?

I am hot! And I am bothered! And it is not just a problem with Sydney's weather!

How is it that mortgage funds - especially US mortgage funds - are already making comeback? How can history repeat itself so quickly?

It was only 8 years ago that the global economy, and Australian economy along with it, suffered the pain & indignity of the GFC.

One of the multi-year impacts of the GFC was that thousands and thousands of individual investors, had their money frozen in dozens and dozens of mortgage funds, when all of a sudden these popular investment vehicles went horribly illiquid.

At a very high level, a mortgage fund is a simple thing:

That is ... until the music stops ... and eventually ... the music always stops.

The music stops because there is a fundamental product design flaw with mortgage funds, in that investors have the general expectation that they can withdraw their money at any time; and most of the time this is true. But mortgage funds lend the assets of the fund to people who will potentially have their mortgages for a long time. So there is a fundamental time horizon mismatch between the lenders and the borrowers.

The music stops when investors get nervous, and many of them want to withdraw from the mortgage fund at the same time. Such as in a property market crash or economic downturn. In extreme circumstances, the manager of the mortgage fund deals with this in the only way possible, which is by suspending redemptions, thereby turning the mortgage fund illiquid.

One of BigFuture's first education pieces was about the importance of time horizon when investing. In that piece we wrote:

"One of the single best ways to sabotage your investment portfolio is to have a mismatch between your investment time horizon and the minimum investment time horizons of the types of asset in which you are investing. This seems obvious, but investors and even professional product providers, muck this up on a regular basis."

Well, here we go again.

I read recently about the imminent listing of the NB Monthly Income Trust on the ASX. [Note: There are probably numerous other similar investment vehicles out there, but this one just happened to pop up on my news feed.]

The NB Monthly Income Trust principally invests in US mortgages. Unfortunately, the illiquidity risk associated with investing in mortgages is not called out on the website describing the trust. Nor is it called out in the marketing flyer.

To the manager's credit, this illiquidity risk is explicitly and repeatedly called out in the Product Disclosure Statement. Unfortunately, anecdotal evidence suggests most investors won't read this document.

Here are several quotes about illiquidity from the Product Disclosure Statement:

This is great information, which all investors contemplating investing in this trust should know. But if great information like this is only available in Product Disclosure Statements, then - sadly - far too many investors will not know.

If I could wish upon a star, I'd wish that:

Your thoughts?

PS: As I wrote this, I was reminded of a satirical comedy sketch by John Bird and John Fortune, who explained their take on the cause of the 2007/08 subprime mortgage crisis. I couldn't resist but include it here - enjoy.

About the author
Michael Clancy is a Co-Founder and Director of BigFuture. BigFuture provides its subscribers online financial education and guidance, especially around achieving financial goals and retirement planning. BigFuture has recently implemented Yodlee financial data aggregation to enable subscribers to bring all of their financial information into one central hub including bank account balances, superannuation account balances and share holdings.
This content is provided by BigFuture and does not represent the views of AMP Capital.
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