Australia: Turf war in mortgage fund industry

Aviva today released its review of mortgage funds offered via its Navigator investment platform, with the analysis shedding light on an industry in the midst of a shake-up.

Stuart Fechner, manager Aviva Research, said the review comes during an intriguing development phase for the mortgage industry, with a flood of newer entrants adding considerable spice to the sector. “This combined with recent industry efforts to improve disclosure and transparency has provided much needed impetus to revitalise what in some cases were in danger of becoming fairly tired investment vehicles.

“It is probably fair to say there has been a bit of a turf war between the old school traditional mortgage players and the new kids on the block who have punched above their weight in attracting inflows,” said Stuart. “This has served to give the heavyweights a wake up call to review established processes.

“There are long overdue signs that managers are striving to improve the appeal of these products by, for example committing to enhance cash returns, appointing dedicated arrears recovery resources and enhancing risk prevention policies. We are also comforted there does not seem to be a wide-scale compromising of conservative lending criteria by traditional mortgage funds.”

Stuart said the review demonstrated a continuing trend of funds building up considerable cash mountains, which brings into question if investors are being appropriately compensated for the fees charged on these funds. Increased competition from banks and other entrants has challenged many to find sufficient loan origination to match investor interest.

“While returns from the mortgage fund sector on short and longer term measures have been satisfactory with most managers providing a modest premium above cash, these returns have to be considered within the context of fees, returns available from alternative income-focussed vehicles and the level of risk inherent in the fund compared to various other income based alternatives,” said Stuart.

“We question whether it is appropriate for investors to be paying this level of fees considering the amount invested in cash. It would be a timely and commendable gesture for some managers to rebate a portion of their fees back to investors,” he said.

Aviva Research’s review covered seven mortgage funds from six managers with the primary objective to identify quality managers and funds.

“This is a select group of mortgage funds with coverage in both the traditional and higher yield sectors. Many of these managers are familiar household names with resilient, stable processes run by highly experienced investment teams that at the top end have broadly delivered satisfactory performance over a long period,” remarked Stuart.

The following funds received a four star rating signifying a high level of confidence in the manager’s investment process and the comparative investment appeal of the funds:

• Australian Unity Wholesale Mortgage Income Trust
• AXA Wholesale Australian Monthly Income Fund
• Challenger Howard Wholesale Mortgage Fund
• Perpetual Wholesale Monthly Income Fund.

While no funds were awarded a five star rating, Aviva Research maintains mortgage funds can make a valued contribution to a well diversified portfolio providing the risks are understood. The inclusion of construction and development lending and mezzanine finance typical of the higher yield offerings exposes these funds to more specialised lending where the risks to investors are greater.

Aviva Research found that assessing the risk attributes of mortgage funds is a complex process which cannot be truly evaluated by a single simplistic measure such as maximum LVR (loan to valuation ratio). Factors such as the amount of construction and development lending, loans to vacant land, presence of specialised lending, geographic diversification of the loan book and the robustness and diversity of the manager’s loan origination network were all vital ingredients in the risk mix.

“I think the most pleasing news for investors is the ongoing expansion of investment choice in the income space. Whether a mortgage fund remains the best available product to meet investor’s income and yield objectives is a matter for investor discretion but clearly, advisers remain attracted to these products,” said Stuart.

Full details of the research are available to advisers who use Navigator, enabling them to better assess the potential of specific mortgage fund investments for their clients.

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Stuart Fechner is available for interview on 0407 839 080.

Attached
- Aviva Research rating methodology
- Aviva Research rating definitions

For further information please contact:
Tim Cobb
General Manager Marketing and Public Relations
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Notes to editors:

• Aviva Australia is a group of two specialist financial services companies: Navigator and Norwich Union Life Australia Ltd. Portfolio Partners is the Australian funds management arm of Aviva plc. Through these companies we provide products and services in the areas of wealth creation and wealth protection for more than 300,000 customers throughout Australia.
• Globally, Aviva Australia is part of Aviva plc, the world’s fifth-largest insurance group, the UK’s largest insurance services provider (based on gross worldwide premiums at 31 December 2005), and one of the leading providers of life and pension products to Europe, with substantial positions in other markets around the world. 
• Aviva’s principal business activities are long-term savings, fund management and general insurance, with worldwide total sales of A$82.3 billion (Ł35 billion) and assets under management of A$745 billion (Ł317 billion) at 31 December 2005.
• The information in this document reflects Aviva Australia Holdings Limited (ABN 38 095 045 784) understanding of existing legislation, proposed legislation, rulings etc as at the date of issue. In some cases the information has been provided to us by third parties. While it is believed the information is accurate and reliable, this is not guaranteed in any way. The information given in this document is of a general nature and has not taken into account the investment objectives, financial situation or particular needs of any particular person and it is not a substitute for professional advice. Applications to invest in a financial product issued by Aviva, or any of its related entities, must be made by completing the application form attached to the applicable Product Disclosure Statement ("PDS"). A PDS is available from Aviva or your financial adviser. Before making an investment decision on the basis of the information above, a prospective investor needs to consider, with or without the assistance of a professional adviser whether the information is appropriate in the light of their particular investment needs, objectives and financial circumstances. Aviva does not receive any remuneration in relation to the provision of information available from this press release which is of a general nature only.

Rating methodology
Aviva Research strives to provide a valuable and reliable service to financial planners by identifying and monitoring quality managers and funds. As part of this service, Aviva Research reviews each asset class on an annual basis and produces individual managed fund ratings based on the characteristics, performance and risk of those funds. Ratings are formulated under a rigorous program of comprehensive fund manager visits, quantitative assessment of performance data and an extensive peer review process.

The assessment criteria allocates 60% of the rating to qualitative factors related to the fund manager and investment process, and 40% of the rating to quantitative performance and risk factors. Qualitative factors are weighted more heavily as Aviva Research believes that positive quantitative results are more likely to be achieved if the fund manager, investment process, investment team and the fund itself all exhibit strong features.

Rating definitions
The final ratings are based on a 5 star system, with any fund rated 3 stars or higher considered to be "investment grade". The definition of each rating is as follows: