When evaluating the strengths and drawbacks of different investment options, one question that often comes up is: what are mortgage trusts, and how can they benefit your wealth creation strategy?
A mortgage trust is an investment vehicle designed to generate targeted returns. It operates by pooling capital from multiple investors to provide loans for property-related projects. As an investor in a mortgage trust, you are essentially participating in a lending business, with the potential to earn a share of the interest generated from a portfolio of loans, all of which are secured by registered mortgages over Australian real estate.
As a unique, property-based investment option, this structure offers a way to gain exposure to the returns of the property sector without the costs and management responsibilities of direct property ownership. The primary goal of a professionally managed mortgage trust is to generate a competitive targeted income stream, which, if successful, is paid to investors as distributions.
At ASCF, we specialise in providing these kinds of property-secured investment opportunities.
How Do Mortgage Trusts Work?
The mechanics of mortgage trusts in Australia are reasonably straightforward, with every step overseen by a dedicated fund manager. At a basic level, this includes:
- Investors Pool Their Capital: Investors purchase ‘units’ in the trust with a set minimum investment. This capital is then pooled into a larger fund to create significant lending capacity.
- Disciplined Lending Oversight: The manager deploys the pooled capital into a diverse range of underlying short-term loans, typically between 1 and 24 months, for business, investment, or personal purposes. This includes coded loans under the National Credit Code, such as owner-occupier and residential investment loans. Adhering to a strict risk-based lending policy, the Funds distinguish themselves by lending only against the current assessed value of a property at the time of the loan. ASCF explicitly excludes property development loans based on “as if complete” or anticipated future valuations.
- Loans are Secured: Every loan is secured by a registered mortgage over real property. This property acts as collateral, which is a key strategy in mitigating investors’ exposure to risk.
- Income is Generated: Borrowers make interest payments on their loans. This income, less any fees paid to the manager, constitutes the trust’s profit.
- Targeted Distributions: Investors aim to receive monthly income based on a Targeted Distribution Rate that is set at the commencement of their specific Investment Term. Unlike models where returns fluctuate directly with monthly fund performance, ASCF investors aim to receive a targeted rate corresponding to their chosen term and Fund.
Essentially, you are investing in a professionally managed portfolio of loans, and the return you potentially receive is your share of the interest earned.
The Importance of Professional Management
An experienced investment manager underpins the success of all reputable mortgage income trusts. Their role is comprehensive, covering the entire lifecycle of the investment process to aim to protect investor capital while generating targeted returns. The fund manager’s primary mandate is to make investment decisions that are in the interests of investors and in accordance with the Fund’s investment mandate. Disciplines and responsibilities involved in a fund manager’s role include:
- Sourcing and Due Diligence: Sourcing suitable loan opportunities and conducting extensive due diligence on potential borrowers, their projects, and the underlying security properties.
- Risk Assessment and Mitigation: Structuring loans defensively to aim to protect investor capital. A critical tool for this is enforcing a conservative Loan-to-Valuation Ratio (LVR), which can provide a protective buffer in case of a default.
- Exit Strategy Verification: Ensuring every short-term loan is anchored by a clear, realistic, and verifiable exit strategy—such as the impending sale of the property or a refinance—to facilitate the timely repayment of the underlying loan.
- Portfolio Management: Building and overseeing a diversified portfolio of loans. By spreading investments across various geographic locations, property types, and borrowers, the manager can reduce the risk of any single loan impacting the fund’s overall returns.
- Ongoing Administration: Handling all administration once a loan is funded, including collecting repayments, and managing the trust’s cash flow and liquidity to meet investor distributions.
A strong fund manager is defined by their experience in the property and credit markets, their discipline in adhering to the fund’s investment mandate, and their ability to proactively manage risk.
Pooled vs. Contributory Mortgage Trusts
In Australia, mortgage investment trusts generally come in two main structures. Understanding the difference is crucial, as it defines the control and diversification potential you have as an investor. At ASCF, we exclusively offer pooled mortgage trusts, as we believe this structure provides an attractive balance of risk management, diversification, and income objectives for our investors.
Pooled Mortgage Trust
This is the most common mortgage trust structure. In a pooled mortgage trust, pooled capital from multiple sources is distributed across a diverse range of loans throughout various property markets. Features of this structure include:
- Diversification: Your investment is spread across many different loans, borrowers, and property types, such as residential and commercial property. This geographic diversification spread is a key benefit, as most pooled mortgage trusts aim to reduce concentration risk.
- Shared Risk & Return: All investors share in the potential income and risks of the entire portfolio. The potential negative impact of a single loan default may be reduced by the performance of the other loans.
- Passive Investment: The investment manager makes all lending decisions, making it a passive investment for you. Your due diligence is focused on the quality of the manager and their investment mandate.
Contributory Mortgage Trust
A contributory mortgage trust (sometimes called a direct investment or syndicate) operates differently from a pooled mortgage trust. The manager sources specific loans and presents them to investors, who can then choose which individual loan they want to fund. Features of this structure include:
- Concentrated Risk: Your entire return is tied to the performance of the loans you select. There is no diversification benefit within the trust to protect you from a borrower defaulting on the relevant loan.
- Active Investor Control: You have direct control over which loan(s) your money goes into, but this also means you bear the full responsibility for that calculated investment decision.
- Capital Commitment: Your capital is generally aligned with the term of the specific loan you fund. While some funds may provide periodic withdrawal opportunities, you should typically expect your capital to remain deployed until the borrower repays the underlying loan.
| Feature | Pooled Mortgage Trust | Contributory Mortgage Trust |
| Diversification | High (spread across many loans) | Low/None (tied to a specific loan or loans) |
| Risk Profile | Shared across all investors and mortgage assets | Concentrated on the investor and specific loan |
| Investor Control | Passive (manager decides) | Active (investor chooses loan) |
| Liquidity | Possible withdrawals (subject to terms) | Term-aligned (typically held until loan repayment) |
Benefits of Investing in a Mortgage Trust
For the right investor, mortgage trusts can be a productive addition to a personal portfolio. Common benefits include:
Targeted Income Generation
The primary appeal is the potential to earn targeted passive income to meet future cashflow requirements. Mortgage trusts are designed to target specific income returns via interest payments from the underlying mortgage assets. In exchange for seeking potentially higher returns than traditional cash-style investments, investors should be aware that these products carry a proportionately higher level of risk, including the risk of capital loss and fluctuating distributions. Many trusts also offer distribution reinvestment plans (DRPs) to allow your earnings to compound over time.
Disclaimer: Returns are not guaranteed, nor is the repayment of capital. Future distributions may vary and are subject to fund performance and liquidity.
Professional Portfolio Management
Investing gives you access to an experienced investment manager who handles the complex process of sourcing loans, conducting due diligence, verifying exit strategies, and overseeing the portfolio. Professional management can save you the time and skill required for direct investing while also applying established lending and portfolio management processes.
Property Sector Exposure & Diversification
As a unique, property-based investment option, mortgage trusts offer an accessible way to enhance a diversified investment portfolio by adding exposure to the Australian property market without the large capital outlay of buying a property. As an asset class, property-backed debt can diversify a portfolio beyond shares and bonds, and may include other underlying investments related to property finance.
Mortgage Trust vs. Mortgage Funds
In the Australian investment landscape, the terms “mortgage trusts” and “mortgage funds” are often used interchangeably, which can cause confusion.
From a practical standpoint, there is very little difference between a mortgage trust and a mortgage fund. Both terms describe a managed investment that pools investor money to lend out via property-secured loans. The term “Trust” refers to the specific legal structure that the investment vehicle uses. Virtually all mortgage funds in Australia are legally structured as trusts.
Therefore, an investor should focus less on the name and more on the underlying characteristics of the product. Some good questions to ask when considering a mortgage trust (or fund) include:
- Is it pooled or contributory?
- What is the manager’s investment philosophy and process?
- What is the lending strategy?
Ultimately, both terms lead to the same type of investment opportunity.
Key Risks to Consider
For investors, proactive risk management begins with understanding that all investments involve risk and are not government-guaranteed. We recommend that investors obtain professional advice to review these risks, which are outlined in detail in the PDS and TMD. It’s important to review these documents, particularly the risk section, and seek advice if anything is unclear to you.
Lending Risk and Loan-to-Valuation Ratios (LVRs)
A key lending risk is that a borrower may default. Managing LVRs—the ratio of the loan amount against the property’s market value—is key to mitigating this risk. Enforcing appropriate LVRs provides a buffer if the property must be sold to recoup the invested capital.
Liquidity Risk
While the underlying mortgage loans held by the Funds are short-term in nature (typically between 1 and 24 months), they are not “at call” assets. This means the Funds are not necessarily designed to meet immediate cash requirements.
Investors can access their capital at the expiration of their selected Investment Term, provided the required Withdrawal Notice Period has been met. However, you should be aware of the following liquidity constraints:
- Conversion to Cash: Real property and mortgage assets are inherently illiquid and cannot always be readily converted to cash to meet liabilities or unexpected withdrawal volumes.
- Frozen Redemptions: In the event that a Fund holds insufficient liquid assets, the Responsible Entity may suspend or delay the payment of withdrawals to protect the interests of all investors as a whole.
- No Secondary Market: There is no established external market to sell your Units, meaning you cannot easily trade your investment to another party for cash. Because your capital is generally committed for the duration of the 3 to 24-month investment term, investors should ensure their funds are suitable for the selected investment term and Withdrawal Notice Period, as access to capital is aligned with these timeframes.
Property Market Risk
The performance of the market and mortgage trusts is linked. A downturn in the property market can correlate with increased defaults and decreased security property values. An experienced manager must understand property market cycles and current market demand to navigate these risks. Diversifying the portfolio can help minimise exposure to any single market segment or phase of the property market cycle.
Is a Mortgage Trust Right for You?
Determining if a mortgage trust is a suitable investment requires a careful assessment of your personal circumstances to ensure the trust’s portfolio aligns with your personal needs and specific financial goals.
Our mortgage investment funds are open to a broad range of individuals, including retail investors as well as wholesale and sophisticated investors. Generally speaking, they suit investors who are:
- Seeking Targeted Returns: Your primary goal is to receive passive targeted investment returns.
- Have a Medium-Term Horizon: You are comfortable with the inherent liquidity risk and do not need immediate access to your invested funds.
- Have a Moderate Risk Tolerance: You understand that to achieve higher returns, your capital is at risk, and returns are not guaranteed.
Interested in learning more? Contact our team or get started with the application process today.
This article provides general financial product advice only. It is always recommended that you seek personal advice from a licensed financial adviser. They can assess your financial situation and objectives. Before making any further investment decisions, you must read the relevant Product Disclosure Statements (PDS) and Target Market Determinations (TMD) documents in full.
