Mortgage funds good for security but growth's a problem

By MARK FRYER

Security remains priority number one for many investors, judging from the managed funds business.

Fund managers have had some good news lately, as investors begin to return, but the majority of those investors have been heading in just one direction - safe-and-steady mortgage funds.

In the latest three months, to the end of September, figures from research company FundSource show the amount of new money flowing into mortgage funds exceeded withdrawals by a very healthy $206 million.

While some other types of funds also attracted an inflow of new money, mortgage funds were by far the most popular. The 11 funds on the market now manage $3.24 billion.

As the name suggests, mortgage funds take investors' money and use it to make mortgage loans, or buy existing ones. Investors then receive the interest payments on those mortgages, after the manager deducts fees and expenses.

It's a relatively low-return investment, but also a relatively low-risk one. While returns will vary, depending on interest rates, history suggests that investors should not get their hopes up.

Over the latest 12 months, to the end of September, the average mortgage fund returned 3.78 per cent, after tax and ongoing management fees. If you're on the 33 per cent tax bracket, that's the equivalent of earning 5.64 per cent before tax.

That's much the same as an investor could have earned by putting their money into the obvious alternative, a bank term deposit, although mortgage funds can be more flexible than term deposits. The fact that the boom in mortgage funds began around three years ago suggests it is largely a reaction to the losses many investors suffered on other types of managed funds, particularly those investing in international shares.

FundSource business manager Tim Anderson says that, to some extent, the popularity of mortgage funds is a result of the banks encouraging customers to move from term deposits to managed funds.

The flood of money into mortgage funds also has one negative. Some funds, says FundSource, have as much as 30 per cent of their money in short-term investments, waiting to be invested in mortgages.

Since interest rates on short-term investments are lower than they are on mortgages, that could reduce future returns.

Anderson points to a less obvious danger: "The risk of putting your money into mortgage funds is that you are going to miss out on those potential returns that you would have got with equities or with other growth assets."

Since March there had been a huge improvement in international markets.