Portfolio manager says advisors can take advantage of illiquidity premium and a lower correlation to public equities
CMLS Asset Management is opening up its mortgage fund to retail investors, confident it has the expertise and resources to provide consistent yield in these challenging COVID-19 times and beyond.
CMLS is one of the largest mortgage finance companies in Canada with more than $24 billion in assets under administration. The CMLS Mortgage Fund has a 12-year track record and was originally created to give partners an opportunity to invest alongside institutional clients. Its strategy has been expanded to enhance returns by investing in inefficient markets, aiming to continue providing a 5-7% average return net of fees.
Sean Adamick, portfolio manager responsible for the execution of fund strategy, told WP it currently has about $40 million AUM. He is cognizant of growing the fund in a measured way and believes it fits well with high-net-worth or mass affluent clients that are looking to harvest an illiquidity premium by shifting some of their allocation from public debt to private debt.
He said: “[An advisor] is picking up two things from this strategy – an illiquidity premium and a lower correlation to public equities.
“From a correlation perspective, if you bring the example back down to your own personal residence, and you think of the equity in your home, for example, that is the first thing to get volatile as housing prices go down. Your equity can very well go to zero, but your mortgage never goes away.
“The volatility really gets wrapped up in that equity component, whereas your mortgage, your debt component, doesn't move. In essence, that's the lack of correlation we're trying to achieve. I encourage anyone interested to get in touch with our national sales director Cynthia Maisonneuve.”
Established in 1974 in partnership with Phillips, Hager & North, CMLS is now management owned and has eight national offices across Canada. The firm has more than 45 years of experience originating and underwriting mortgages for some of the largest institutional investors across the country. It originated more than $6 billion of mortgages in 2019 and has over 360 specialists providing investment management services to individuals, advisors and institutions.
Adamick uses the iceberg analogy to describe the evolution of their business model, featuring three main components: finding or originating the loans, adjudicating the loans (underwriting) and then monitoring them through the loan life cycle.
Adamick said: “We have been doing this for 45 years and have really refined that process – that’s really the ‘below-the-water’ component of that iceberg. What we’re doing with this fund is just overlaying a portfolio construction and a cash management process to our existing infrastructure.
“We’ve taken the individual services that we have refined over the past number of years and are now offering it as a package to investors that we really haven’t typically offered it to.”
He explained that offering one-off services to institutional investors who might need a billion dollars of commercial mortgages makes sense. However, CMLS realizes there is a whole market of investors that have between $25,000 or hundreds of thousands of dollars that just don’t have access to this type of product.
He added: “All we’re doing is putting our services together, wrapping it up and doing what we do for our other institutional investors, but in a pooled vehicle targeted at smaller investors.”
The portfolio manager compared the shock of the pandemic as akin to a classic negative supply shock that might occur because of a big earthquake, flood or fire, except on a global scale, adding that it is morphing into a demand shock as consumers are forced to stay-in-place. He conceded that retail-oriented real estate has been affected – April rents were dismal and May will likely be worse - but said that, having avoided commodity driven markets and kept the retail portion of the fund to about 12%, he remained comfortable with CMLS’s position.
A large majority of the portfolio (66%) is housing-related and needs-based, which is typically a lower volatility sector and a sector getting a lot of government attention and support. CMLS also has very little exposure to land and construction, only 1% to seniors housing and no hotels. It currently has 10% cash and an untapped 18% line of credit, so feels well positioned if and when opportunities arise.
COVID-19 will have a deeper impact on the broader market and people’s long-term saving plans, however. Adamick believes the next 10 years will bring an even lower level of interest rate than the past 10 years, which means yield will be harder to come by and it will be harder for people to achieve their retirement goals. However, a low interest rate environment bodes well for the value of real assets like real estate, as we’ve seen over the past 10 years since the global financial crisis.
He said: “I would expect investors to continue to move a portion of their allocation into the private space to harvest an illiquidity premium as returns on publicly traded assets get driven lower. Just to be clear, we aren’t trying to grab 100% of an investor’s fixed income allocation; it’s just a component of a broader strategy that your advisor has prepared.
“Most investors have a certain amount of cash they aren’t necessarily going to need in the near term or that they may never touch. The options for that investor are to invest in public markets that are liquid or to invest in private markets that are illiquid. Many don't necessarily realize that by choosing the public market option, you're actually paying for liquidity you’ll never need so it’s the not the most efficient use of capital
“So, we're saying to people – take the money you're never going to touch and harvest that illiquidity premium because you are paying for having it in the public markets.”