Money: Topsy turvy for trusts

By ANNE CUNNINGHAME

Just what is happening with mortgage trusts?

WestpacTrust's new fund, launched in April, has raked in $110 million and ASB Bank's year-old mortgage trust is going from strength to strength, swelling by $92 million in the six months to March.

However, these two buck the trend, which has seen older funds lose money as investors ditch income assets in favour of growth.

Research house IPAC Securities shows $125.8 million flowing out of mortgage trusts in the March year, from a sector worth $1.45 billion.

Several banks admit they set up the trusts to attract money out of term deposits and, beyond that, to lure customers into other managed funds with higher margins. They are relatively simple products, making them easy for advisers and branch staff to sell.

And some banks have structured their funds in such a way that they are off-balance sheet, freeing up capital for other lending (they say that if this was not the case, there would be little advantage over funding housing and other loans from the likes of term deposits).

But is that money going to stick? In some cases, it has been bouncing back into term deposits or out the door as people chase what they see as higher returns and less hassle.

To make them worth considering, the returns on mortgage trusts need to be higher than a term deposit, even after fees. However, the catch is whether investors perceive they are getting better value, particularly in a falling rate environment.

As for ASB Bank and WestpacTrust's funds, one theory is that their current charm is partly due to their relative newness to the banks' investors and sales staff. Other fund managers say it can take up to three years for the investor base to "mature," that is for people to start wondering whether they are getting adequate reward.

Grant Hill, product manager of managed funds for BNZ investments and insurance, says the bank's Mortgage Income Fund, launched in 1987, has lost money from retail investors (although overall totals have been boosted by investment from BNZ's new Capital Enhanced Fund).

So where are those investors heading? "With us," says Mr Hill, "there's typically not a lot of churning between products. They're moving back to term deposits and not necessarily with us: these people are very interest-rate conscious."

He says there needs to be sharper communication from fund managers to educate people about investing in mortgage trusts, pointing out that the BNZ Mortgage Income Trust has consistently remained at a margin above the bank's highest term deposit rates (see graph).

He says investors can confuse past and future returns: they might compare current term deposit rates with last year's return on the fund.

Mr Hill says when interest rates head up and get close to their peak, there are strong inflows. When the trend is downward and flatter, there are more withdrawals.

While last year's declining interest rates saw many mortgage trusts suffer, Mr Hill says that given the current trend in rates there could soon be another cycle of strong net inflows. "We want to make sure that we can outperform term deposits. Two to three years ago, the margin on lending and borrowing was greater, but now it's contracted quite a bit, it's harder to meet that value proposition. But the fund has still grown quite nicely."

The largest mortgage fund is Guardian Trust's, with $275 million under management at the end of March and most of its assets in commercial and rural mortgages. The newest kid on the block is WestpacTrust, which launched its Home Loan Trust in April.

WestpacTrust's manager of investment products, Stephen Stewart, says the bank identified a gap in its product line-up, after losing money to competitors' products. He says a quarter of the money now in the trust is new money to the bank.

Most of it is from existing customers but quite a bit comes from typical term investors putting their toe in the water of unit trusts.

"We have a lot of customers who have 90-day term deposit rollovers, so we're effectively giving them a floating rate return with a regular income.

"We're also picking up people who have had money and other investments with other banks."

ASB Bank's chief manager of investment services, Roger Perry, gives three reasons why his bank's Residential Mortgage Trust is proving so popular.

"Firstly, it complements the product range, providing a floating rate yield in an environment where rates are rising. When it was launched last July, some investors were reluctant to lock into term deposits when rates were expected to go up.

"Two, the product can provide a regular income stream. It has a monthly distribution which will vary, but you can also set regular payment options on a fortnightly or monthly basis.

"Thirdly, it's a very simple product, very transparent."

Mr Perry says that the bank's investment advisers often recommend to retired customers a mix of this trust for income purposes and some growth assets.

The entry level has been set at $10,000, well above that of other funds.

"The bank didn't want it being seen as another savings account - we're not trying to cannibalise those."

How the trust funds are invested and what you can expect after fees


Mortgage trusts compete with term deposits, cash management trusts and bonds. They invest in mortgages in a bid to achieve higher returns than the basic term deposit but still at relatively low risk.

Mortgage trusts are mostly structured as unit trusts by the banks and as group investment funds by the trustee companies. They generally pay out all their income to investors, so there is no capital growth.

Returns are affected by the type of mortgage invested in: if they are other than low-loan-to-valuation-ratio residential ones, returns should be higher but so is the risk. For example, WestpacTrust's fund invests in residential first mortgages with a maximum 80 per cent loan-to-valuation ratio, ASB Bank similarly but with a 75 per cent maximum, while the non-bank funds usually have at least some assets in commercial and rural mortgages.

How much they hold in cash (to meet investor withdrawals and/or because they cannot find enough suitable mortgages to invest in) can also affect returns.

Other points to look at:

Fees: Some funds will slice 1 per cent off your money if you withdraw it with less than 30 days' notice; others have an exit fee of 1.5 per cent if you take out money in the first year. Other fees include entry fee (anything from 0 to 2 per cent) and annual management and trustee fees (0.85 to 1.6 per cent).

The funds management expense ratio, if available, should give you the best indicator of ongoing expenses.

Minimum entry levels: In many cases $1000 will get you in, but for WestpacTrust's fund you will need $5000 and for ASB Bank $10,000.

Income stream: Payments will fluctuate depending on interest rate trends (there will be more of a lag behind the market if the fund invests in fixed rather than floating rate mortgages).

Most funds distribute income quarterly, the ASB fund pays out monthly and the BNZ's fund makes no distributions.

Returns: These are tightly grouped, so the ongoing fees certainly have an impact. One-year net returns (after fees and tax) at the end of May ranged from 3.3 to 4.3 per cent and five-year returns from 4.5 to 5.4 per cent.

* Anne Cunninghame is a freelance financial writer.