How pooled mortgage funds can generate a healthy income

It’s no secret real estate can be a rock-solid foundation for portfolios, particularly in today’s high-inflation environment, in which hard assets often rise in value.

What’s known less is the potential value of pooled mortgage funds. It’s a corner of the real estate market that often generates yields exceeding those found in traditional fixed income – all without the volatility of equity exposure found in many real estate investment trusts (REITs).

Pooled mortgage funds aren’t new but have grown in popularity over the past decade among institutional investors and advisors who serve high-net-worth clients.

“In the simplest terms, a pooled mortgage fund is a basket of mortgages that runs much like a mutual fund. It delivers returns to investors generated by interest from these mortgages,” says Vikram Rajagopalan, executive managing director, and global head of capital raising at Trez Capital.

The Vancouver-based firm is Canada’s largest, non-bank commercial lender. Trez Capital manages four private market pooled mortgage funds, and the firm has surpassed $4-billion in assets under management (AUM).

These funds give advisors a different pool to swim in, offering diversification and steady yields for income-seeking clients.

For example, Trez Capital Prime Trust TRZ410.CF has a 15-year history of producing steady yields.

“It’s our most conservative fund with a loan-to-value [ratio] of 55 to 65 per cent, with investors looking at annualized returns of about 5 per cent,” Mr. Rajagopalan says.

The target yield for Trez Capital Prime Trust is also 5 per cent.

These investments offer different exposure than most other real estate offerings. Generally, pooled mortgage funds provide short-term, bridge financing to developers and builders in office, multi-family, retail and industrial sectors.

Such funds can typically charge higher interest rates than other lenders. Consequently, pooled mortgage funds often have higher yields than fixed income while being less affected by rising interest rate environments.

Vikram Rajagopalan, executive managing director, and global head of capital raising, Trez CapitalSupplied

A focus on commercial real estate

Some investors confuse pooled mortgage funds with mortgage income corporations (MICs), which can also have relatively high yields. Yet, these two types of investments are quite different, Mr. Rajagopalan says.

In Canada, MICs can only invest in domestic mortgages, and 50 per cent of those assets must be in the residential market.

“In contrast, pooled mortgage funds can invest in all asset classes, but typically focus on commercial real estate,” he says.

Trez Capital Yield Trust TRZ110.CF invests in the Canadian and U.S. commercial markets, targeting a 6 per cent annual yield.

In addition, most pooled mortgage funds operate in the private market, so their performance is less correlated to public markets. That’s unlike many publicly listed MICs and REITs, which are affected negatively by downside stock market volatility.

However, as private investments, one concern for investors is liquidity. In this respect, size matters, Mr. Rajagopalan says.

“In general, mortgage funds, when they get north of $1-billion [in AUM], often offer decent liquidity for investors,” he says.

Still, private market pooled mortgage funds can “gate redemptions” during periods of market upheaval.

“If there’s a market event that causes panic, for example, Trez Capital can gate a fund to protect its investors until conditions are less volatile. Everything we do is with the investor in mind,” Mr. Rajagopalan says.

The ability to manage liquidity helps private market pooled funds continue to generate interest returns from underlying assets. That happens without the pressure that publicly traded REITs, MICs and bond funds often go through, as they must offer intraday trading that can have a negative impact on underlying assets.

Understanding the management strategies

No two pooled mortgage funds are the same. Their management is a focus for advisors who look for a long history of steady returns. Another key trait that advisors look for is forward thinking.

“At Trez Capital, we’ve always tried to be innovators, going where others may fear to tread, at first,” Mr. Rajagopalan says. “Many doubted us when we went into Texas and started lending to developers in 2010 after the global financial crisis.”

Yet, the strategy turned out to be one that other fund managers emulated over the past decade. Trez Capital Yield Trust U.S. has generated a steady yield of about 7 per cent annually over that time span, Mr. Rajagopalan reports.

The fund’s success reflects a strategy of leveraging a “boots on the ground” approach, with local expertise to invest in emerging, long-term trends – all before these markets become crowded by other investors.

In short, the best pooled mortgage fund managers have constantly evolving views on investing.

For instance, Trez Capital has shifted over its 25-year history from focusing on Western Canada to expanding across the nation, particularly in the Greater Toronto Area in recent years.

And after dipping into the U.S. a decade ago, Trez Capital has expanded from multi-family and storage unit developers in Texas to take on a wide range of projects across Florida and many other states.

“Our strategy today is really on growth markets in the Sun Belt states,” Mr. Rajagopalan says.

Still, pooled mortgage funds aren’t a one-stop solution product for income-seeking investors. Rather, these funds are designed to be part of a larger, well-diversified portfolio to offer stable income that’s often uncorrelated from other holdings, Mr. Rajagopalan says.

“As [fund] managers, we wake up thinking every day that our clients want income and stability. Not home runs, but a steady stream of singles they can count on in their portfolios to help achieve their goals,” he says.

Advertising feature produced by Globe Content Studio with Trez Capital. The Globe’s editorial department was not involved.