How mortgage income funds work: A guide for wholesale investors

How mortgage income funds generate returns

Returns are primarily derived from the interest income paid by borrowers. Mortgage income funds may offer attractive yields due to:

• Urgency or complexity of borrower requirements
• Specialised lending (e.g. bridging loans, SMSF loans)
• Streamlined approval processes compared to traditional banks

Some funds may also reinvest distributions, enabling compounding returns through the issuance of new units. While the fund manager may receive fees for origination and management, income distributed to investors is net of such costs.

Security and risk mitigation

A major feature of mortgage income funds is the secured nature of the underlying loans. In the event of borrower default, the fund may enforce its security over the property to recover outstanding principal and interest.

Common security features:

• Registered first mortgages: Priority claim over sale proceeds
• Conservative LVRs: Typically below 80% to protect capital
• Due diligence: Borrower credit assessment, asset review, and serviceability analysis
• Valuation protocols: Independent or desktop valuations inform loan decisions
• Diversification: Exposure is spread across multiple loans and borrowers

Key risks:

• Liquidity risk: Redemptions may be limited to specific windows (e.g. quarterly)
• Credit risk: Defaults may occur due to borrower-specific or macroeconomic factors
• Interest rate risk: Fixed-rate loans may underperform in rising rate environments
• Property market risk: A downturn in Australian real estate may impact loan recoveries

Accessing mortgage income funds as a wholesale investor

Access to most funds is typically restricted to those who qualify as wholesale investors under Australian law. You may qualify if you:

• Hold net assets of $2.5 million, or
• Have earned $250,000 or more in each of the past two years (certified by an accountant), or
• Are a professional investor or invest $500,000 or more in a single transaction

General investment process:

1. Review the Information Memorandum (IM) and fund documents
2. Confirm eligibility and provide documentation
3. Complete application forms and provide KYC/AML compliance documents
4. Transfer funds to the designated custodian account
5. Receive confirmation of investment and unit allotment

Minimum investments typically range from $50,000 to $250,000, with lower thresholds for top-ups.

Comparing mortgage income funds with other income strategies

Mortgage income funds differ from traditional corporate bond funds or property equity investments by focusing on private, secured lending backed by real assets.

Benefits for wholesale investors:

• Attractive risk-adjusted returns: Funds often target returns that are above the Reserve Bank of Australia’s Overnight Cash Rate (OCR)
• Regular distributions: Income typically paid quarterly or monthly, suiting SMSFs and income-focused investors
• Capital preservation: Property security and conservative LVRs reduce downside risk
• Portfolio diversification: Low correlation to shares and listed fixed income markets
• Private market access: Exposure to high-quality real estate credit not typically available to retail investors

Final thoughts

Mortgage income funds are well-suited to wholesale investors seeking consistent income, capital protection, and diversification away from traditional asset classes. By investing in property-backed credit, these funds offer a compelling addition to a fixed income allocation.

As with any investment, potential investors should undertake their own due diligence and consult with a licensed financial adviser to assess whether such funds align with their financial objectives and risk tolerance.