The news of Woodford raising the largest new issue for investment trust for the year hit all the headlines, but the second-pace fundraise has not garnered anywhere near as many column inches.
While eclipsed by Woodford’s Patient Capital trust, which raised £800m, the UK Mortgages trust raised £325m.
However, the team behind the launch, which comes from TwentyFour Asset Management, decided to cap the book size at £250m for fear of capacity constraints.
The trust invests in books of UK-based residential mortgages, keeping the investment mandate narrow to the UK and not venturing into commercial property.
“What we are trying to do is find assets to create a predictable income stream for investors,” says Ben Hayward, one of the trust’s managers. He is seeking mortgages that have a “very strong performance profile over a very long period of time.”
In particular, Hayward looks at the track record of the mortgage book, to ensure solid payments and lower default rates. For new originations of mortgages, where no track record is available, he instead looks at the lender and their track record. “We want high quality borrowers in pool,” he says.
It is these tighter investment parameters that led to Hayward restricting the money coming in.
“We wanted to be more conservative and prudent around how much cash we took, particularly as we had to execute on a relatively certain timeframe,” he says.
The trust’s fee structure also penalises the managers for not fully investing the fund. If, after a six months, any money raised in the initial public offering is not invested, TwentyFour stops taking a fee on it, which is 0.75 per cent of the lower of the assets or the NAV.
Beyond that, if at the 12 month period the fund is not 75 per cent invested or more then a continuation vote is held among shareholders. A continuation vote is also held if the fund does not deliver 6p per share in a 12 month period.
The fund does not charge a performance fee, and it’s ongoing costs are around 1 per cent, although most of the charges are fixed so Hayward envisages that cost coming down as the fund grows.
Part of the product’s appeal was investors’ keen appetite for income at the moment, says Hayward. The fund aims to deliver a net total return of 7 to 10 per cent, once it is fully invested.
“For a while we’ve seen very strong demand for income products. We are paying out an attractive income and an income that is floating rate – that resonates a lot for a lot of investors at the moment,” he says.
“It’s a bit different, I think people are always looking for slightly different ideas, and it is largely non-correlated to existing asset classes, it’s not been done before.”
To achieve the targeted income, the fund uses leverage, of around four to seven times the fund. However, Hayward says this has to be seen in light of the big players in the mortgage market, such as the banks and building societies, who are typically levered 22 times.
“The only debt we issue will be AAA-rated debt. The rating on the debt is decided by the ratings agency, which looks at the quality of the mortgage pool,” he says. “If the mortgage pool is lower risk we can have more leverage and it’s higher risk then we can have less leverage. They set the amount of debt we can issue and set the amount of leverage we can have.”
With talk of an interest rate rise in the UK getting nearer, the UK’s reliance on floating rate mortgages has come into focus. However, Hayward is not concerned about a drastic pick-up in default rates affecting his investments.
Borrowers are stress tested up to 7 per cent rates, he says, while a 50 basis point rise in the base rate, and so mortgage rates, is unlikely to have a material difference for most borrowers.
“Undoubtedly there will be the marginal borrowers that find it harder to service that debt,” he says.