The housing market might be down, but that has not eliminated the $13 trillion mortgage marketplace, which is rich with investment opportunities.
Tapping into those opportunities is the main objective of the new Vertical Capital Income Fund, which will invest exclusively in individual residential mortgages.
“One of the real attractions of this investment is it doesn't correlate closely with equity and most bond markets,” said Bayard Closser, manager of the fund and president of Vertical Capital Markets Group.
The one-of-a-kind fund, which currently is funded with seed capital and does not yet have a ticker symbol, gives retail investors access to a strategy that Mr. Closser is already offering to accredited investors through private-placement vehicles.
The fund, which could eventually hold thousands of individual mortgages, will start buying its first mortgages next month, he said.
“We are looking to purchase discounted mortgages, sometimes as cheap as 60 cents on the dollar,” he said.
Prior to the financial crisis, Vertical Capital was operating as a mortgage-origination firm, but as the mortgage market dried up, Mr. Closser saw an opportunity in the secondary market to trade mortgages directly with banks looking to add or reduce their mortgage exposure and capital requirements.
While the bulk of the residential mortgage market already is wrapped up into residential-mortgage-backed securities, Mr. Closser is concentrating on those mortgages that have not been syndicated in the RMBS space.
There is an estimated $3 trillion in nonpackaged individual mortgages held by banks, many of which looking to offload some risk.
“With this strategy we are providing some liquidity for financial institutions,” Mr. Closser said, explaining that the market presents investment opportunities.
In the process of purchasing loans, Vertical Group researches both the property and the borrower, the same way as it would have if it were originating the loan. Vertical Group is also servicing the loans and has the ability to modify individual loans if necessary.
“We are buying the actual mortgages, and there are risks associated with strategic defaults [when borrowers abandon a home] and foreclosures,” Mr. Closser said. “Through this structure, the fund will own the underlying collateral in the event of a loan default.”
He also pointed out that, despite all the fear and gloom surrounding the housing market, “87% of borrowers pay their mortgages like clockwork, whether they're currently underwater on their loan or not.”
The fund is structured as a continuously offered closed-end fund, which makes it a kind of hybrid between a closed-end and open-end mutual fund.
From an investor's perspective, the structure equates to reduced liquidity.
“The fund looks and acts like an open-end fund, but liquidity is limited to a quarterly tender offer,” Mr. Closser said.
The limited liquidity is a result of the unique nature of the underlying assets. Buying and selling an individual mortgage can take up to 45 days because they don't trade on exchanges like stocks.
The ultimate appeal, however, is a new entry point to the real estate sector for smaller investors.
According to a study by
BlackRock Investments LLC, between 2001 and 2010 the Barclays Capital U.S. MBS Index, the Vertical fund's benchmark, had a -0.18 correlation to the S&P 500.
