The recent announcements by several mortgage and property trusts freezing or suspending repayments or redemptions from mortgage and property trusts has raised questions in the minds of investors. Business Editor Dene Mackenzie investigates.
Investors purchase units in the trusts and the investor funds are used to provide mortgages to borrowers backed by quality property investments, or in the case of property trusts, to buy property.
Income for the trust comes from interest on the mortgages, or in the case of property, the tenants pay rental.
The interest and rent received by the fund is distributed to investors and provide a regular flow of earnings, normally by quarterly distributions.
In order to maximise earnings for the benefit of investors, a high percentage of the funds are invested in quality mortgages or quality properties with a relatively small portion held in cash to accommodate requests for repayments that are both expected and planned for.
In the past, the cash buffer has been adequate to meet demand for repayment in normal market conditions.
The difficulty that has arisen for these funds is that the growing lack of investor confidence and uncertainty has resulted in a significant increase in requests for repayments as people react to market turbulence.
This sudden and abnormal increase in requests for repayment is stretching the cash buffer held by the funds.
The managers have announced suspensions or a freeze to provide time to allow the market to return to a more normal situation as they cannot accommodate a dramatic increase in repayment requests.
Source: Investment Savings and Insurance Association.
THE OPTIONSPage 26Frozen assets . . .
AMP is one of four large companies to close redemptions on funds as they try and cool the market.
GRAPHIC: ODT ARTIST INVESTORS have been drawing their money out of mortgage trusts and property funds as fast they can.
Fund monitoring and research firm FundSource says close to $300 million has been pulled out of mortgage trusts and property funds in the past three months alone.
Mortgage trusts are not designed to stand up to high levels of redemptions.
They only carry a certain amount of cash.
Once that is used up, they start selling off loans or asking borrowers to pay the money back in order to pay out investors.
The sudden rush for withdrawals has forced funds to stop the withdrawals.
AXA's mortgage-backed bonds was the latest to stop redemptions.
AMP Capital Investors stopped redemptions for its $420 million New Zealand property fund.
It followed Guardian Mortgage Trust, which has $240 million, the $60 million Totara First Mortgage fund and the $250 million Canterbury Mortgage Trust.
Investment Savings and Insurance Association chief executive Vince Arkinstall is doing his best to soothe troubled waters.
"The first point is that the fund managers have taken this action not because of any problems or concerns with the quality of assets or investments but purely as a defensive measure in response to extraordinary market conditions.
"There is no suggestion that any assets or investments are impaired."
But he admits that there could be further mortgage or property funds announcing a freeze.
If calls for repayments continued to outstrip the cash buffer available, then other managers might have no option but to limit repayments.
That was not an indication of any market failure, only a prudent reaction to a cash-flow issue, he said.
Dunedin financial planner Peter Smith said that in many respects, the recent freezing of funds had been caused by investors having a lack of confidence in the funds.
"It is clearly understood that nobody likes to lose capital so an orderly wind-up is most likely the answer to protect all.
"It is unfortunate that the loss of investor confidence has resulted in all funds lending on property being considered equal where the good, the bad, the evil - and possibly the fraudulent -have been lumped together as `bad'."
All advisers could do was to try to calm investors by pointing out that freezing improved security and the prudent thing to do for the benefit of all investors.
Mr Smith, the principal of Peter Smith Financial Services, was urging clients to be calm and not put pressure on fund managers by withdrawing when they did not need the money.
All personal portfolios had different levels of liquidity within them.
It required investors to look carefully at the underlying assets of the funds - particularly mortgage funds - where by freezing now, the security was superior to bank deposits.
"Bank deposits are only as secure as the bank itself as they are not directly secured by a physical asset.
"I'm not suggesting any bank is in trouble but they have had to write off large loans whereas the provision for bad debts in mortgage funds has been very small in proportion to the banks' write-offs," he said.
Dunedin investment consultant James Reid said what had been a surprise in the latest round of financial shocks had been the number of "big names", such as AMP and AXA, closing their funds.
The Guardian Mortgage Trust had been in existence for more than 20 years and had a good record.
In the majority of cases, the potential for investors to recover a large proportion of their funds was high as several of the trusts had adopted a responsible attitude towards their lending practices and had also acted early in closing their funds to protect existing depositors.
Several funds would not be in a position to recover investors' funds entirely and investors would again have a long wait before they learnt the final outcome, he said.
"What hasn't been so widely reported has been the meltdown of a number of innovative fixed interest offerings which have been marketed to the general public over the past few years."
While not as prevalent and well known as finance company debentures, the other "alternative" fixed interest products had been promoted on the basis of their so-called security and higher return than what had been offered by more mainstream fixed interest securities.
They had been packaged up and made to look simple when in reality they were hugely complex and should have been sold to sophisticated investors only, Mr Reid, the principal of Reid Asset Management Ltd, said.
"Interestingly enough, these same products would not have been allowed to be sold to retail clients in some overseas countries given their complexity and underlying risky nature.
"In New Zealand, a large number of these investors have absolutely no idea what they have invested in and believe that if they wait long enough, their money will be returned."
What was "particularly unfortunate" was the number of financial advisers recommending those products and who had no idea what they were, he said.
They also believed that if investors waited long enough, their clients' funds would be returned.
Recently, Australian and global banks had taken significant write-downs as a result of their exposure to similar financially-engineered securities.
"This in itself should highlight how unlikely it will be that investors in New Zealand with these types of securities will recover a large proportion of their funds," Mr Reid said.
Craig Myles, of Myles Wealth Management, said New Zealanders were phenomenal at "taking new things on board" but often that meant rushing from one side of the boat to the other.
"Often they are investing in the last asset that just delivered the best result. That is unlikely to be the asset that delivers next," he said.
Mr Myles understood that the AXA and AMP funds were both open to wholesale investors such as institutions, superannuation funds and advisory groups.
The wholesale investors had started asking for redemptions and the funds did not have enough cash, forcing them to freeze the payouts.
It was no different than the investors owning the mortgages themselves.
If a private investor had lent money on a three-year mortgage, the only way to convert that to cash was to sell the mortgage to someone else.
"You just can't turn around to the person and say you want all your money back."
