Mortgage funds are devising new rules for paying out investors to inject certainty into the market.

Mortgage trusts are starting to emerge from the state of limbo in which they have operated over the past 12 months, with some funds replacing their limited and uncertain facilities of the past year with permanent liquidity arrangements.

However, investors will have to decide whether to stay in funds that no longer offer withdrawal at call, as they did in the past. And investors in a large number of mortgage trusts are still waiting for their fund managers to work out a stable, long-term approach to managing liquidity risk in their funds. The pace of change has been slow.

The research company Lonsec has reviewed the sector and changed its ratings on a number of funds from "hold" to "recommended", having come to the view that the sector has stabilised. The underlying business of the trusts remains sound, unit prices have remained steady and there has been no loss of capital value.

Within the next couple of weeks Balmain Funds will issue a new prospectus for its $140 million Balmain Mortgage Trust. Units will be sold on a term basis, with investors having the options of 18- or 36-month terms.

Fund managers in the $20 billion market are taking different approaches.

In June, Australian Unity introduced a monthly redemption facility for its Mortgage Income Trust, with 1 per cent of the value of the fund available for redemption each month. In October it increased that amount to 2 per cent a month. Perpetual has settled on quarterly redemption for its Monthly Income fund, with all available cash to be allocated for redemption on a pro-rata basis. Some managers are yet to finalise their long-term arrangements.

A spokesman for Challenger, Stuart Barton, says the group is still working on a couple of options for the Challenger Howard Mortgage Trust. Colonial First State and ING Australia are still working with the interim arrangements they put in place last year.

In the past, investors in mortgage trusts had their money at call and would usually get their cash within a week of making a redemption request. The Australian Government's decision in October last year to provide a guarantee on deposits held with approved deposit-taking institutions contributed to a run on mortgage trusts and forced them to suspend or limit redemptions.

The industry acknowledged that once it had dealt with the immediate problem created by the financial crisis it would have to put liquidity rules in place that reflected the fact that the assets in which the funds invested - mortgages with three- to five-year terms - were not liquid assets.

The industry body, the Investment and Financial Services Association, put together a mortgage trust working group earlier this year with the aim of coming up with a single liquidity solution but managers could not agree on a single outcome. This means investors will have to get used to a variety of term structures and redemption arrangements.

The chief executive of Balmain Funds, John Thomas, says investors already in the fund will be given the choice of moving to a 36-month term or maintaining their current arrangement and being paid out over time.

Mortgage trusts have attracted two types of investors: retirees who are looking for regular income from a relatively low-risk asset and investors who are parking their cash. The funds will not be stabilised until the short-term investors are paid out.

Thomas says that when the Balmain Mortgage Trust last paid redemptions, in September, 22 per cent of unit holders applied to get money out. "Our estimate is that 65 to 70 per cent of existing unit holders will stay long term," he says.

Australian Unity's retail general manager, Adam Coughlan, says about 30 per cent to 40 per cent of the money in the group's Mortgage Income Trust is short-term and will be paid out over time. He says the group's aim is to increase the amount available for redemptions each month to 4 per cent.

The Perpetual group's executive for income and multi-sector funds, Richard Brandweiner, says retail investors making redemptions over the past year have already got back an average of 90 per cent of their balances.

In August, Lonsec restored investment-grade ratings to several funds, including Balmain Mortgage Trust, Perpetual Monthly Income, Challenger Howard Mortgage Trust, Australian Unity Mortgage Income, Axa Monthly Income and ING Mortgage No. 2.

The researcher's review says: "While the sector continues to face ongoing issues at the product and macro level impeding its relative investment attractiveness, there is now sufficient market stability to suggest that the most challenging period for these funds, responding to the large volume of investor outflows, may have passed."

Hardship relief

The Corporations Act requires the operator of a managed investment scheme to treat all investors equally, so if there are restrictions on redemptions, all investors are affected. However, the Australian Securities and Investments Commission provides relief for hardship cases.

Applicants for hardship relief must show they are in a position of severe financial or personal hardship or are permanently incapacitated.

The cap on hardship withdrawals is $100,000 a year and an investor can make four hardship withdrawals a year (up to the cap of $1 million).

In September, ASIC expanded the hardship grounds to include assistance for the beneficiary of a deceased estate, where the beneficiary is suffering hardship. The grounds also include people unemployed for at least three months and with no means of support apart from government assistance.

Personal hardship means you are unable to meet reasonable and immediate living expenses. Financial hardship means you have a binding financial obligation and you do not have capacity to meet the obligation.

MORTGAGE FUND REDEMPTIONS               
Fund Name                       Net Assests             Redemptions
                                $m      
Advance Mortgage                        41.39   Suspended until further notice.
Aust Unity High Yield Mortgage  432.15  Suspended until further notice.
Aust Unity Mortgage Income              984.22  Monthly, up to 1% of total investment in the fund.
AXA - Australian Income         272.47  Quarterly, subject to available cash and demand.
AXA - Australian Monthly Income 665.54  Quarterly, subject to available cash and demand.
Balmain Mortgage Trust          140.00  New product disclosure pending. 18 or 36 mnth fixed term.
Challenger Howard Mortgage              1166.65 Quarterly, on a pro-rata basis subject to available liquidity
Colonial First State Income             1024.18 Quarterly, on a pro-rata basis subject to available liquidity
ING Monthly Income                      138.8   Quarterly, based on maturity of securities in portfolio
ING OneAnswer IP ING Mortgage No. 2     179.38  To make quarterly withdrawls subject to available liquidity
LM Mortage Income Fund          498.74  Suspended indefinitely
MacarthurCook Mortgage Fund     —       Quarterly, on a pro-rata basis subject to available liquidity
Perpetual Monthly Income                1076.21 Quarterly, on a pro-rata basis subject to available liquidity
Richmond Mortgage                       91.94   Granted only on the basis of hardship
Wright Patton Shakespeare No. 2 5.55    Suspension period extended, likely until 5 May 2014
SOURCE: MORNINGSTAR