When it comes to constructing a well-balanced fixed-income portfolio, the geographic distribution of assets often gets neglected. In the hunt for yield, portfolio managers often place far greater emphasis on factors such as size, value, momentum, quality and volatility. For mortgage investors, however, geographic diversification is critical.
Although geographic diversification often carries a business connotation—namely, a process of acquiring and distributing assets across various geographic locations—for private mortgage portfolios, it has a more specific meaning. For mortgage investors seeking exposure to the residential property market, geographic diversification is more than just a growth strategy—it ensures the health and sustainability of their investment portfolio over the long run. To understand why, we can simply look at the current mortgage market and the major clusters of competition that are driving down yields. Mortgage portfolios that intend to meet their specific yield targets should therefore be actively pursuing geographic diversification.
Increased Competition
Mortgage investments used to cater to a very narrow segment of the investment community. That quickly changed as more investors began to educate themselves about the benefits of private mortgages. Changes in federal mortgage guidelines and growing demand for alternative lenders have combined with a sharp decline in corporate and government bond yields to give investors newfound reason to explore these investment options. However, mortgage lenders have deployed capital mainly in dense urban markets, which has put downward pressure on interest rates. Funds with primary exposure to these markets have therefore been less competitive due to compressed yields.
Nowhere is this more apparent than in the Greater Toronto Area, or GTA. Canada’s largest mortgage market has seen a softening of yield due to this narrow lending focus, especially among alternative lenders looking to deploy capital as quickly and efficiently as possible. Given the short duration of these portfolios, increased competition can quickly diminish fund performance.
Attractive Yields in Other Jurisdictions
Geographic diversification, like other forms of diversification, is the financial equivalent of not putting all your eggs in a single basket. For wholesale mortgage investors, this means expanding beyond the Greater Toronto Area. Unfortunately, many mortgage portfolio managers do not have the expertise or geographic reach to lend in markets beyond the GTA. For those that do, smaller cities and towns across the country typically have higher yields.
Beyond the obvious yield advantage, geographic distribution allows investors to expand their horizons without the risk of over-concentration. While it is certainly true that the Greater Toronto Area is home to more investment opportunities, remaining hyper-focused on one region could have an adverse effect on returns over the long term, especially when increased competition is present.
Portfolio diversification remains one of the most important risk management principles in all of investment. When it comes to private mortgages, geography plays an important role.
CMI Mortgage Investments offer investors direct exposure to Canada’s largest mortgage markets with a strong focus on risk management and geographic distribution. Learn more about our investment process or contact one of our investment managers for a free consultation.
