Firstmac’s High Livez may be high risk

Firstmac, an Australian finance company has been promoting its premier fund, called the High Livez Investment Fund and advertising on TV to drum up investments.

We’re not exactly sure how Firstmac came up with the name but here’s the details.

High Livez was launched in early 2011 and is structured as a trust. The trust made a return of 10.5% in the year to August 31, 2103 with distributions (if any) usually made on a monthly basis. Firstmac has paid a monthly distribution since inception, but investors need to be aware that it is not guaranteed. The trust will initially invest up to 90% of assets in Firstmac asset-backed securities, but should decrease as the trust grows in size. Perpetual’s (ASX: PPT) Trust Services is the Responsible Entity and custodian.

Those asset-back securities are actually RMBS, or residential mortgage-backed securities, meaning the securities consistent of hundreds or even thousands of Australian home loans. Firstmac suggests that its asset-backed securities are lower risk than Australian and International equities, as well as property and compares its RMBS as falling between cash and fixed income securities. However, RMBS securities are debt securities and could be higher risk products than they appear at first glance.

Investors will remember that RMBS were part of the reason for the GFC, where ratings agencies assigned investment grades to certain assets that woefully underplayed the risks involved. While High Livez doesn’t appear to be taking the same risks, investors should remember that its assets are not risk free.

Mortgage securitisation can be an effective tool but unforeseen circumstances can create problems. Here in Australia, several companies that competed against the major banks by securitising their mortgages went to the wall, with the highest profile one of them all RHG Limited (ASX: RHG), previously Rams Home Loans, selling everything but its loan book to Westpac Banking Corporation (ASX: WBC), after credit markets closed in the wake of the GFC. While Firtsmac has issued RMBS since 2002 including through the GFC, black swan events can’t be ruled out.

Investors considering an investment in the High Livez Trust will also need to consider several other risks with Firstmac listing several in the Product Disclosure Statement (PDS) including counterparty risk, RMBS risk, interest rate risk, market risk, liquidity risk, regulatory risk, Firstmac risk, capital risk, global economic conditions, credit risk, manager risk and last but not least compliance risk. To be fair to Firstmac, the company is required to list every possible risk in its PDS and these risks would also apply to other RMBS trusts. Some of these risk will obviously be highly unlikely and a lower magnitude of risk than others.

Investors also need to be aware of the potential conflict of interest between Firstmac’s role as manager of the fund, and its commercial interest as the issuer of RMBS. Firstmac says it has controls in place, including a rule to not acquire more than 75% of a Firstmac RMBS tranch, and controls are monitored by Perpetual Trustees.

Foolish takeaway

With some commentators expressing concerns about a housing bubble beginning in Australia (or perhaps fully developed, depending on who you ask), investors need to have their eyes wide open when considering an investment in High Livez. While most RMBS issues in Australia are backed by Lenders Mortgage Insurance (LMI), issuers of RMBS, including the four major banks as well as many other financial institutions, would then be reliant upon the strength of the LMI providers to cover any shortfall if borrowers default.

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Motley Fool writer/analyst Mike King doesn’t own shares in any companies mentioned.

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