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HSBC Mortgage
The HSBC Mortgage fund had an average annual return of 4.95% over the five years ended September 30th, keeping pace with the average Canadian mortgage fund. The Scotia Capital Markets (SCM) Mortgage index is a natural benchmark for this fund and returned an average of 7.7% over the same period. However, my examination of the fund suggests that a reasonable benchmark for this fund would lie somewhere between the SCM Mortgage index and the 91-day Treasury Bill index, which had a 4.2% five-year average annual yield. An index of near-term government bonds would be ideal. Since the beginning of the year, as domestic interest rates went on a bit of a roller-coaster ride, the fund gained 2.9% compared to the Treasury Bill index's 2.1% and the SCM Mortgage index's 5.4%. The fund has a management team of three, including Jim Huggan, a member of the HSBC Asset Management Fixed Income team. The fund invests primarily in first residential mortgages which it buys exclusively from HSBC Bank or its subsidiaries. The mortgages have maturities of between six months and five years, and are uninsured, which means that the debtors have made down-payments of at least 25%. Like a bond fund, the mortgage fund manages its average maturity with a greater maturity signaling greater sensitivity to interest rates. An internal benchmark with a maturity of two years currently defines a neutral position for the fund. The fund does not invest in so-called mortgage-backed securities (MBS's), which are traded instruments. The lower volatility of pure mortgages compared to MBS's is consistent with Mr. Huggan's view of the fund as one that adds value over conventional money market funds. Adding to the relative safety of the fund is an arrangement whereby HSBC Bank will repurchase mortgages that have been in default for over ninety days as if no default had occurred. The fund pays a fee of 0.25% at the time of purchase for this insurance, effectively eliminating most default risk. The same arrangement also allows the fund to sell mortgages back to the bank on favourable terms in the event that it needs to increase liquidity. As a result, the mortgages in the portfolio act like near-term government bonds. At the end of the third quarter, the fund held about six-hundred mortgages representing 85% of assets, cash and T-bills made up 13.4% of the fund, and 1.6% was in corporate paper. The portfolio had a weighted-average term-to-maturity of 2.04 years, with 40% (by market value) of its mortgages set to mature between now and December 2004. The longest mortgages in the portfolio were set to mature no later than July 2009. Using additional information from the June 30th semi-annual financial statements, the fund's mortgage holdings had an unweighted average interest rate of about 6% on a principal amount totaling just over $200 million. The corporate bonds held by the fund were issued by the 407 ETR corporation and Ford Credit Canada. Earlier this year, as bond yields rose, the fund started to increase its cash position, which was up to 20% going into the second quarter. This move was good for the fund's performance in the first half of the year. When yields began dropping in May and June the fund deployed some of this cash. However, as Mr. Huggan admits, the deployment was too slow and the fund missed much of the rally in the bond market. As a result the fund has been uncharacteristically lagging its peer group in the short term. Going forward, Mr. Huggan sees more likelihood of near-term upward pressure on 3-5 year bond yields rather than on shorter maturities, and has adopted a neutral stance on interest rates. The fund's 1.52% MER makes it the least expensive nationally-available open-ended mortgage fund. It has also been the most successful in that class over ten years, returning an average of 6.36% annually. Such performance certainly represents value added over the average money market fund, which saw an average annual return of 3.7% over the same period. The fund is available at no load for a modest minimum investment of $500. It can be purchased directly from HSBC bank or through other dealers and brokers. The HSBC Mortgage Fund offers an attractive alternative to temporarily 'park' cash. It is also appropriate for conservative frugal investors who want to give the money-market component of their fixed-income portfolio an additional boost. FF: Q3 2003 |
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