David Prosser looks at the new launch, Twenty Four Asset Management’s UK Mortgages.
Most financial advisers will know all about the biggest investment company launch of the year so far – if you missed Neil Woodford’s £800m fund-raising for his new Patient Capital fund, you must have been in hibernation. But how many advisers can name the second-biggest fund raiser of 2015.
In fact, the fund in question closed to new investors earlier this month. Twenty Four Asset Management’s UK Mortgages picked up £250m from investors, though it could have raised substantially more – the fund was over-subscribed by £75m.
As the name suggests, the fund buys up portfolios of UK residential mortgage loans. You might be surprised by the demand from investors for such a vehicle – after all, weren’t securitised mortgages at the root of the disastrous credit crunch of eight years ago?
The answer to that question is yes. But the low-quality sub-prime US mortgages that triggered the crisis are a million miles away from what UK Mortgages intends to put investors’ money into. It promises to stick to blue-chip mortgages in this country – it will look for existing packages of loans that can demonstrate robust past performance figures, as well as new portfolios where the underwriting standards meet certain tests.
The default rate on such mortgages is remarkably low, UK Mortgages’ managers point out. It peaked at around 0.78 per cent a year in 1991, when interest rates were at 14 per cent, and has been falling ever since. Even during the credit crisis, the default rate didn’t rise about 0.2 per cent.
Bear in mind too, that default does not mean loss. Mortgages are secured on residential property, which can be sold to repay the loan. The proceeds may not be enough, of course, but house price growth in recent years will help – as will the conservative loans to value with which mortgage lenders have been operating since the credit crisis.
That is not to say there is no risk at all. After all, with interest rates having been held at historic lows since the crisis, it would have been odd if this hadn’t been a golden period for low default rates – we will have to see what happens if, as now looks increasingly likely, rates start to rise again next year.
Still, the payback for the risk is a target annual return of between 7 and 10 per cent, most of which UK Mortgages intends to pay out as income. For all those investors who have struggled to find decent yields on their savings and investments in recent times, those figures look very alluring.
Indeed, the demand for income-generating investments is a big part of the explanation for the increase over the last couple of years in the number of investment companies offering exposure to debt. The nature of the underlying investment varies from peer-to-peer finance to convertible securities but this is a sector that now comprises almost 20 funds – in some cases, these funds offer double-digit yields to income-starved investors.
However, it’s only closed-end funds that can operate comfortably in this space. The illiquidity of the underlying holdings would make them tricky for an open-ended fund to deal with given the ebbs and flows of investors’ money into and out of these vehicles. Also, unlike open-ended funds, investment companies have the option of taking on gearing, with managers able to borrow with the aim of enhancing returns. This is one reason why the yields on these funds are so high.
Debt funds won’t suit everyone, of course. But they do potentially give financial advisers another option as they try to find new sources of income for their clients. There’s a good chance UK Mortgages won’t be the last launch in this area.