But can you cash in your investment?

April 8 2010 by Ellen Roseman

Although interest rates are close to zero, you can still earn higher returns on higher-risk interest investments. Recently, I did a column about Romspen Mortgage Investment Fund, which says at its website that it has generated consistent returns of about 10 per cent a year.

The fund invests in commercial mortgages that banks don’t generally handle. It’s open only to accredited investors and doesn’t have to issue a prospectus, as mutual funds do. There’s no market for the units, since they’re not listed on a stock exchange.

But I didn’t realize how the lack of liquidity played out in the months following the 2008 stock market crash. A financial adviser told me that his client had tried to redeem units and couldn’t because everyone else wanted to do the same thing. That made me press company spokesman Wes Roitman for more details — and he happily obliged.

You can read the questions below from Ken Hawkins, the adviser, and Romspen’s response. It’s clear that the double-digit returns on a private mortgage fund may cost you dearly if you expect ease of cashability in an emergency.

7 comments

  1. Ken Hawkins, Weigh House Investor Services

    Apr 8 2010

    We had a client who had a significant amount invested with Romspen, so I took a look at it in the fall of 2008.

    He was raving about it because of the 10% yield and the fact that it did not go down, compared to the market.

    We suggested he call Romspen to redeem all his units. They told him he was unable to do it. They had too many people ahead of him.

    The problem I have with Romspen is that they show the value of their portfolio at book value, not market value. They assume the prices remain constant, although the market value of the underlying assets will have dropped. That certainly was the case during the credit crisis.

    At the moment I do not know if I can trust the value of the units that they represent fair market value.

    Another thing that bothers me is that there does not appear to be a custodian on the securities in the fund and that the Trustees of the fund are the management of Romspen!

    In a chart from Romspen, they show that the units have lower risk than T-bills. I believe that is only because they do not value the portfolio on its actual market value.

  2. Romspen client

    Apr 8 2010

    While it is undoubtedly true (and very important to note) that the Romspen fund is much riskier than a GIC, you seemed to emphasize the negative in your article.

    For example, you indicated “still its quarterly distributions to investors fell to 21 cents last year from 24 to 25 cents in most previous quarters.” It might have been helpful to note that this resulted in a drop in annual return from roughly 9.6% to roughly 8.4%.

    In a year when many people with investments in the stock market lost 30% or 40% of their capital, Romspen not only retained all capital but made only a slightly lower rate of return than in previous years.

    Perhaps it would be fair to point out that earning 0.001% on a GIC also involves risk — the risk of not keeping up with inflation and of running out of money.

    There is no free lunch except, some say, diversification. The investing world is enormously complicated. But Romspen’s track record certainly makes it worthy of consideration for part of a well-balanced portfolio.

    The liquidity issue may not be surprising, given that the underlying securities are mortgages which cannot always be quickly liquidated.

    I think the liquidity issue has been addressed by Romspen in the last few months by amending its documents to provide rules that govern in the event of a rush to the door.

    The valuation and liquidity issues could be cured by taking the venture public, though the costs of doing so would ultimately be born by the investor.

    You are certainly better off to emphasize the negative in an investment like this one. But I for one still think there is value in Romspen. Its long-term record (and its record through the recent downturn, valuation issue aside) is pretty impressive.

    PS The trust FC.UN, which trades on the TSX, bears some similarity to Romspen (in my view). Of course, since it is publicly traded, it does not have the valuation and liquidity issues.

  3. Wesley Roitman, managing general partner

    Apr 8 2010

    About liquidity, we had a situation during the Lehman meltdown and ensuing panic with investors wanting to redeem.

    Since we are not exchange traded, our liquidity mechanism is limited to the natural cash flow of the portfolio, namely new investors buying units and mortgage repayments, to fund redemptions.

    We have a limit of 1% per month (approx. $5m) and a monthly limit with a queue system if requests exceed 1% in any month.

    This limit has very rarely been exceeded in our history; however, the circumstances in late 2008 were extraordinary.

    The problem with the queue system, we discovered, is that when you have a panic and investors hear that there is a queue of several months, many of them start to game the system. They take a number in the queue, just in case they may need their money.

    So instead of just those who really need or want their money asking for it, we had many more requests, which in turn brings out even more.

    We paid out the full 1% limit for about 8 or 9 months, and each month we had to deal with people whose number would come up and then they didn’t actually want their money back, just asking us to put their name back on the list for next month.

    The vast majority of our investors did not want to redeem and some of the larger ones suggested that since these relatively few investors were behaving in a manner that was harmful to the overall fund, that we should amend the trust declaration.

    So we consulted with several of our larger investors and following their input put a change in the redemption provisions to a vote of the investors at our annual unitholders meeting. It was approved by over 90% of the unitholders.

    Now when the queue exceeds 3 months, we can offer unitholders an immediate ‘market related’ discounted payment, and they can elect to either take that immediate payment or hold their units for one year.

    We also have the option of suspending redemptions for a period of up to 6 months. When we offered immediate discounted redemption to those still on the list after the AGM, not a single one opted for the early repayment.

    About Fair market value, the financial planner you quote is not correct. KPMG values our mortgages at fair market value, as required by the CICA handbook because they are financial instruments.

    It just so happens that the value of a short term mortgage is determined not so much by fluctuations in market rates. The values of properties on which we have mortgages are reviewed by our auditors annually and if they decline below the mortgage amount, then a reserve is taken.

    The reason the mortgage values rarely fall below book is simply that the property values themselves must fall significantly, often by more than 30% or 40%, before it impacts the mortgage value.

    I should also say that we find that we have many detractors among the community of commission-based financial planners and investment brokers – so it is not surprising to hear from one such individual recommending their client liquidate. They don’t like to recommend us because we pay no trailers and no commissions to them whatsoever.

    We have several who invest their own money with us, but not their clients’ money. The fee-based ones are a smaller group and we have better experience with them.

    About the Custodian, we discussed this with Computershare, who act as our transfer agents. We concluded it would be highly cumbersome and provide no additional security for investors to have them hold our mortgages. They would simply act on instructions from us and the fund would have to indemnify them in full.

    Unlike liquid securities, such as shares in a common mutual fund, mortgages require someone to process large quantities of paper for title registries. condo plans, plans of subdivision, rights of way, and discharges, need to be dealt with in a timely manner and it simply would not work well to interpose a third party in that role.

    It is more common in the securitized mortgage business, but those loans are all ‘no change’ type loans, unlike development properties where lots of title activity is taking place.

    About independence, all the trustees believe that there is not much value added by so-called independent trustees or corporate directors, who generally have little personal investment, receive fees, and know very little about the business other than what management tells them. Every corporate train wreck of the last decade had independent directors.

    Our trustees are collectively the single largest investors and possess the most knowledge about the assets we manage. Not to mention, all of us have our wives, mothers, family and friends money invested too.

    Generally, we don’t think like Wall St. or Bay St. people and we don’t buy into a lot of their methods. As a rule, their interests are more aligned with securities issuers, not investors, so they pacify investors with these rule-based constructs like custodians and independent directors, which do next to nothing but add to the cost.

    We think it is better to align ourselves squarely with our investors and then let our investors decide for themselves whether or not we are trustworthy.

  4. Ken Hawkins’ response

    Apr 8 2010

    KPMG’s estimate of fair value does not represent the “market” value. The market value represents what people will be willing to pay for something.

    The fact that so many people wanted to get out is a reflection that the “market value” was considerably lower than “book” value.

    I recommended that our client redeem his shares in Rompsen because in the fall of 2008, risky assets all over the world were dropping, including high quality corporate bonds.

    According to the redemption rules, he should be able to get out at book value of about $10. We believed the market value of the units were well below $10 and if you can sell something at $10 that might only be worth $9, I will reccommend that to all my clients all the time.

    Now many other unit holders wanted to get out as well, suggesting we were correct in our assessment.

    Custodian and independent directors and trustees are part of good corporate governance. (Talk to some of the other directors at FAIR Canada, especially Claude Lamoureux and Stephen Jarislowsky, about the importance of good corporate governance and whether or not Rompsen follows good corporate governance.)

    I understand that Bernard Madoff did not have independent trustees or custodians. I am sure he would not have gotten away with his Ponzi scheme if he did.

    Now I am not saying that Romspen are operating a Ponzi scheme, but I am always a little skeptical when investments seem to deliver consistent 10% returns with little or no risk. Is that not the message that Madoff delivered to his clients?

  5. Steve Garganis

    Apr 8 2010

    Great topic for discussion…

    Wow, how can you even include the words ‘Ponzi scheme’ in this discussion? Sorry, but that’s a little harsh…

    Isn’t an RRSP a long term investment? That’s exactly how this investment should be treated… long term…

    And qualifying for this type of investment is strict… $200k annual income, $1 million net worth… the good news is that it limits this to sophisticated investors… the bad news is that it limits this to sophisticated investors…

    I’m not pumping Romspen.. I’ve done very little business with them… but I’ve been in the Mortgage Business for over 20 years and here’s what I can tell you….

    Romspen is a recognized name in the Mortgage Broker community.. They are known as providing solutions for commercial mortgages as well as for short term financing….

    Their annual rate of term is reflective in their pricing…. but this isn’t anything unusual… There are MIC’s (mortgage investment corporations) that offer similar returns….

    It’s really simple math.. look at the average interest rate on these mortgages..12.25%… add in some of the standard fees and it’s easy to make 10% or better…

    There is another great Mortgage investment corp out west called Fisgard Capital Corp., with an 11% annual return over the last 15 years… these aren’t anything new, they are just limited to qualified investors…

  6. bylo

    Apr 8 2010

    > the good news is that it limits this to sophisticated investors

    Would their attempts to game the redemption queue be evidence of their sophistication or their lack thereof? 😉

  7. Wesley Roitman’s response

    Apr 25 2010

    Ken is not the first person to try to compare us to Bernard Madoff because we have a history of low volatility and high returns. Such comparisons display flimsy analysis, emotion or misunderstanding.

    Madoff told people he was trading risky volatile stocks and stock options, while doing so with low volatility and consistent returns.

    At Romspen, we lend money on non-traded private fixed rate mortgages. These loans have a return that is a fixed rate for every investment from the day it’s made to the day it matures. The only variable, other than the average portfolio interest rate, is loan losses.

    It is pretty easy to see how we can achieve our consistency: Keep the losses small.

    Anyone who has ever traded in the stock market, let alone the options market, knows how tough it is to be consistent trading these investments.

    Another difference between mortgages and a stock portfolio printed on a brokerage account statement is that mortgages are registered on land titles. Land titles are maintained on a public registry system, which anyone can search.

    It would be quite impossible to pretend to hold a portfolio of 100 or so large commercial mortgages that didn’t really exist.

    As for governance, I agree we have unusual views. They were formed from our institutional history of syndicating mortgages.

    We could never convince our investors to buy in to any mortgage unless we also agreed to buy in personally and hold the mortgage full term. In our view, this is a far more powerful check and balance than independent oversight by disinterested people.

    If you take up Ken’s suggestion, maybe the Star could also ask Claude Lamoureux how much money his former employer lost recently by investing in subprime CDO’s, ABCP, and the other esoteric innovative investments that followed the Wall and Bay Street model of governance.

    Around the world recently, investors lost hundreds of billions, and our whole financial system nearly collapsed, believing in these false checks and balances.

    A friend recently gave me a copy of Michael Lewis’ book, The Big Short. It is one of many excellent pieces of journalism written recently about the latest trillion dollar subprime mortgage scandal perpetrated by the industry of which Ken is a part.

    I would recommend every investor, and their advisors like Ken too, read this or one of the pieces like it.

    Every bogus high quality triple-A CDO had an independent manager, an independent rating agency, and an investment bank sponsor, all of whom purported to be looking out for the investors. Guess what? They weren’t.

    I bet investors like Mr. Lamoureux’s Ontario Teacher’s Pension Plan would not have lost nearly as much money if, instead of independence, they would have insisted that every one of these fee-driven intermediaries promise to hold the same toxic securities to maturity and not to hedge off the risk, like we do at Romspen.

    The securities industry is supposed to be guardian of a nation’s savings. Instead they have become, in casino talk, the house, and the markets they run, a big casino.

    They don’t care about investors. They care about building up armies of guys like Ken to convince people to buy this and sell that, paying fees along the way, while none of them commit to take the same risks themselves, or worse, sometimes they even take the other side.

    Our investors, by and large, think it’s a fair tradeoff to stay away from that casino. We run a single, easy to understand but hard to execute, business. They get an old-fashioned notion of governance.

    Unfortunately though, they can’t always have their money back exactly when they want. For that matter, they can’t always invest when they want either.

    Interestingly at this moment, we find ourselves with the opposite problem from late 2008 and 2009. We have too much money and we’ve had to temporarily close the fund to new investment. Too bad for Ken’s clients now, they may also have to wait in line to get back in.