Why Mortgages:
An Investment Comparison
© 2012 ACM Advisors Ltd.
Why Mortgages: An Investment Comparison
© 2012 ACM Advisors Ltd.
Page 2 of 11
An historical analysis of leading Canadian commercial mortgage funds versus various fixed income
indices concludes that investments in ACM Advisors Ltd.’s “Mortgage Fund One” and “ACM
Commercial Mortgage Fund” provided investors with superior risk-adjusted returns, low
volatility, increased portfolio diversification and tangible real property security. In addition to
analyzing competitive metrics, this paper provides the reader with an overview of commercial
mortgage fundamentals and the current status of the mortgage and real estate industries in Canada.
The paper concludes that investment portfolios should include an allocation to commercial
mortgages to realize the above-noted benefits and maximize their risk/return profile.
Like a bond, a commercial mortgage is a fixed income instrument that is used to secure the
repayment of a loan for funds advanced to a borrower. Security for these loans is a registered
charge against income-producing real property. The primary types of income-producing assets held
as security by commercial mortgage lenders are retail, office, industrial, and multi-family properties.
Hotels, seniors housing facilities, self-storage facilities, land and manufactured home communities
are less prominent asset classes that may also be used as security.
Industry sources estimate that between $15 and $20 billion of commercial mortgage term loans are
made on average each year in Canada. Primary lenders have included pension funds, life companies,
banks, conduits, credit unions and private groups. Lenders either source investment opportunities
from borrowers directly or through the mortgage brokerage community.
The amount of loan advanced is driven by two key ratios: loan-to-value and debt service coverage.
Institutional lenders have traditionally lent to a maximum of seventy-five percent of the estimated
market value of the property while ensuring that the net operating income generated by the property
is sufficient to cover the annual debt service obligations created by the mortgage to a ratio of not
less than 1.25 times. Adherence to these ratios provides capital and cash flow downside protection
should the property, and/or owner, experience challenges during the course of the loan’s term.
Commercial mortgage loan terms typically range from one to ten years with amortization periods
ranging from fifteen to thirty years with twenty-five years being the most common. Loan
repayments are received on a monthly basis for the term of the mortgage, most often in a blended
form of principal and interest with the outstanding principal balance due at the end of the
mortgage’s term.
Pricing of commercial mortgages has two components: the yield on a term-equivalent Government
of Canada bond and a credit spread. Historically speaking, mortgage credit spreads have averaged
(+/-)150 basis points, with the actual spread being a reflection of the strength and quality of the
borrowing and, if applicable, guarantor entities, property characteristics (asset class, location, tenants,
leases, vacancy rate and income), transaction metrics (loan-to-value and debt service coverage
ratios), and prevailing market conditions.
Why Mortgages: An Investment Comparison
© 2012 ACM Advisors Ltd.
Page 3 of 11
In 2002/2003, the fall-out from the decline in the technology industry resulted in an investor flight
to quality and stability. Real estate and commercial mortgages were positively impacted by this and
both asset classes experienced significant inflows of capital, resulting in downward pressure on
lending credit spreads. Over the next few years, growth from non-traditional mortgage lenders in
the form of conduits (US-based banks securitizing commercial mortgages which were sold to
investors) further increased the amount of capital allocated to the sector. By 2007, competition for
commercial mortgage financing had further intensified and credit spreads for mortgages had
compressed to the 90 to 120 basis point range, which were all-time lows.
Compressed credit spreads continued until the summer of 2007 when the US economy began
showing signs of weakness. What began with defaulting sub-prime residential loans and other
illiquid mortgage-related instruments originated in the US quickly transformed into a worldwide
financial and credit crisis. The crisis evolved into a global recession causing consumer confidence to
falter, financial institutions to fail and, ultimately, the re-pricing of risk across all asset categories. As
a result, commercial mortgage credit spreads widened dramatically from the all-time lows
experienced in 2007 to the 300 to 375 basis point range by the spring of 2009.
Canada weathered the economic downturn significantly better than other countries and, by the end
of 2009, investor confidence returned in moderation. At a macro level, low interest rates, controlled
inflation levels and government stimulus programs provided underlying economic stability. The
fundamentals of the Canadian commercial real estate market remained solid, with conservative
borrower leverage, prudent underwriting criteria and relatively balanced supply and demand levels
cited as the primary drivers of the industry’s resilience. While lease rates and occupancy rates had
moderated in tandem with the slowdown in economic activity, they did so off record highs and had
returned to near-normal historical levels.
On the back of heightened capital market activity, Canadian public real estate investment trusts and
real estate operating companies became flush with cash in the fourth quarter of 2009 and have
continued to satisfactorily raise debt and equity through the public markets. Transaction velocity
accelerated to long-term averages as these owners deployed their substantial cash holdings in
accretive acquisitions. In response, the mortgage lending community returned to the market with
higher allocations to commercial real estate financing in 2010 and 2011. Through the first quarter of
2012, this strong competition has resulted in credit spreads returning to historic norms in the 150 to
200 basis point range for conservatively underwritten first mortgages on institutional quality real
estate with strong borrower and guarantor covenants.
Prudently underwritten commercial mortgages secured by well-located income producing real estate
owned by experienced borrowers represent very good investment opportunities. Driven by the
credit market turmoil of 2008/2009, lending standards have become more stringent and remain
more conservative than historic norms for Canadian lenders. Combined with the healthy credit
spread environment that currently exists, we are of the opinion that this continues to be an excellent
entry point to this asset class for investors via an experienced commercial mortgage manager.
Why Mortgages: An Investment Comparison
© 2012 ACM Advisors Ltd.
Page 4 of 11
This paper compares the historical performance of two leading Canadian commercial mortgage
funds with several fixed income indices. ACM Advisors Ltd.’s “Mortgage Fund One” and “ACM
Commercial Mortgage Fund” were measured against various Canadian fixed income indices
including the DEX Federal (formerly Canada) Bond Index, the DEX Provincial Bond Index, the
DEX Corporate Bond Index, and the DEX Real Return Bond Index. Canadian short-term
investments as represented by the DEX 91-Day Treasury Bills Index were also included in the
analysis.
Established in 1992, Mortgage Fund One is a pooled commercial mortgage fund managed by ACM
Advisors Ltd. for institutional investors. Mortgage Fund One’s well-diversified investment portfolio
comprises conservative mortgages secured by retail, office, industrial and multi-family incomeproducing institutional quality properties owned and managed by top tier public and private real
estate corporations. Properties underlying the mortgages are located in major Canadian economic
centres including Vancouver, Calgary, Edmonton, Ottawa, Toronto and Montreal. As at December
31, 2011, Mortgage Fund One held investments valued at $460 million. Pooled loan-to-value and
debt service coverage ratios were a conservative 55.6% and 1.7X, respectively, and the fund’s
duration was 4.5 years.
Why Mortgages: An Investment Comparison
© 2012 ACM Advisors Ltd.
Page 5 of 11
Established in 2007, the ACM Commercial Mortgage Fund is a pooled commercial mortgage fund
managed by ACM Advisors Ltd. available for investment by private and institutional investors. The
ACM Commercial Mortgage Fund’s well-diversified investment portfolio comprises conservative
mortgages secured by retail, office, industrial and multi-family mid-tier properties owned and
managed by experienced real estate operators. Properties underlying the mortgages are located in
major urban and suburban markets across Canada. As at December 31, 2011, the ACM Commercial
Mortgage Fund held investments valued at $141 million. Pooled loan-to-value and debt service
coverage ratios were a conservative 60.7% and 1.5X, respectively, and the fund’s duration was 3.5
years.
As shown below, an investment in Mortgage Fund One has provided investors with superior returns
on a risk-adjusted (Sharpe ratio) basis, outperforming relevant fixed income indices over the past 15
years. The Sharpe ratio is calculated by subtracting the risk-free rate (91-Day Treasury Bills) from
the annualized return and dividing by the volatility. As such, it is a measure of the return per unit of
risk, i.e. the risk-adjusted return: the higher the ratio, the better the risk-adjusted return.
Fund/Index
Mortgage Fund One
DEX Corporate Bond Index
DEX Universe Bond Index
DEX Provincial Bond Index
DEX Federal Bond Index
DEX Real Return Bond Index
DEX 91-Day Treasury Bills Index
Annual
Return
7.14%
6.94%
6.69%
7.36%
6.25%
9.12%
3.12%
Volatility
2.98%
3.52%
3.68%
4.60%
3.62%
7.22%
0.47%
Sharpe
Ratio
1.35
1.08
0.97
0.92
0.87
0.83
0.00
Note: annualized returns are on a gross basis; volatility measured in standard deviations calculated monthly and annualized.
Index
DEX 91-Day Treasury Bills Index
DEX Federal Bond Index
DEX Universe Bond Index
DEX Corporate Bond Index
DEX Provincial Bond Index
DEX Real Return Bond Index
Excess
Annual Return
4.02%
0.89%
0.45%
0.20%
-0.12%
-1.98%
These results are highly relevant to pension plans, investors, and their advisors. Traditional pension
plan diversification targets have approximately sixty percent of assets invested in fixed income
Why Mortgages: An Investment Comparison
© 2012 ACM Advisors Ltd.
Page 6 of 11
investments and traditional actuarial assumptions have employed a discount rate between 4% and
6% percent for these investments. Ten-year Government of Canada bonds were yielding
approximately 2% percent as at December 31, 2011, resulting in a 2% to 4% deficiency on the fixed
income portion of the average Government of Canada bond portfolio. In order to meet funding
obligations, the typical pension plan and its advisors would have to assume higher levels of risk in
the remaining forty percent of its portfolio.
As shown below, an investment in the ACM Commercial Mortgage Fund has also provided
investors with superior returns on a risk-adjusted (Sharpe ratio) basis, outperforming relevant fixed
income indices. This time period was utilized for the comparison as the ACM Commercial
Mortgage Fund was established in May 2007.
Fund/Index
ACM Commercial Mortgage Fund
DEX Corporate Bond Index
DEX Universe Bond Index
DEX Federal Bond Index
DEX Provincial Bond Index
DEX Real Return Bond Index
DEX 91-Day Treasury Bills Index
Annual
Return
8.74%
7.39%
7.08%
6.51%
7.96%
10.02%
1.77%
Volatility
2.82%
3.34%
3.39%
3.56%
4.81%
10.00%
0.48%
Sharpe
Ratio
2.47
1.68
1.57
1.34
1.29
0.83
0.00
Note: annualized returns are on a net basis for the ACM Commercial Mortgage Fund and a gross basis for all other indices; volatility measured in standard
deviations calculated monthly and annualized.
Index
DEX 91-Day Treasury Bills Index
DEX Federal Bond Index
DEX Universe Bond Index
DEX Corporate Bond Index
DEX Provincial Bond Index
DEX Real Return Bond Index
Excess
Annual Return
6.97%
2.23%
1.66%
1.35%
0.76%
-1.28%
These results should be highly compelling to private clients and their investment advisors. The
ability for individuals to have access to Canadian commercial mortgages as an asset class has been
historically hampered due to the lack of investment vehicles available. By providing exposure to this
asset class and, over the past four plus years, producing returns far in excess of a traditional bond
portfolio with less volatility, the ACM Commercial Mortgage Fund has helped its investors reduce
their overall portfolio risk without sacrificing returns.
Why Mortgages: An Investment Comparison
© 2012 ACM Advisors Ltd.
Page 7 of 11
Correlation measures the relationship between two asset classes, i.e. how the returns of two asset
classes move in relation to each other. In order to reduce the volatility of a portfolio, it is
advantageous that not all asset classes move together. Mortgages exhibit low correlations with other
asset classes, presenting investors with an excellent opportunity to further diversify their portfolios.
As indicated in the table below, the returns of Mortgage Fund One were moderately correlated with
the all-universe Canadian bond index and long term bonds between December 31, 1996 and
December 31, 2011. Otherwise, the fund exhibited extremely low correlation with other bond
indices, Canadian, US and international equity indices and the majority of other asset classes over
this time period.
Asset Class
Fixed Income:
High Yield Bonds
Short-Term Investments
Real Return Bonds
Global Bonds
Long Term Bonds
Universe Bonds
Equity:
Canadian Equities, Small Cap
US Equities, Small Cap
International Equities, Large Cap
Emerging Markets Equities
Global Equities, Large Cap
Canadian Equities, Large Cap
Global Equities, REITs
US Equities, Large Cap
Other:
Hedge Funds
Commodities
Index
Correlation
Merrill Lynch High Yield Master II (C$)
DEX – 91-Day Treasury Bills
DEX – Universe, Real Return
Barclays Global Aggregate (C$)
DEX – Universe, Long Term
DEX – Universe
-0.02
0.08
0.25
0.39
0.66
0.75
BMO – Nesbitt Burns Small Cap Weighted
Russell 2000 (C$)
MSCI – EAFE (C$)
MSCI – Emerging Markets (C$)
MSCI – World (C$)
S&P/TSX Capped Composite
FTSE EPRA/NAREIT Developed
S&P 500 (C$)
-0.13
-0.09
-0.09
-0.09
-0.08
-0.05
-0.04
-0.03
CSFB/Tremont Hedge Fund (C$)
S&P GSCI Commodity (C$)
0.14
0.08
Data source: Aon Hewitt Investment Consulting
Why Mortgages: An Investment Comparison
© 2012 ACM Advisors Ltd.
Page 8 of 11
For the time period of May 31, 2007 to December 31, 2011, the returns of the ACM Commercial
Mortgage Fund exhibited similar correlations with the same indices to those of Mortgage Fund One:
Asset Class
Fixed Income:
Short-Term Investments
High Yield Bonds
Real Return Bonds
Global Bonds
Long Term Bonds
Universe Bonds
Equity:
Canadian Equities, Large Cap
Canadian Equities, REITs
Canadian Equities, Small Cap
US Equities, Small Cap
US Equities, Large Cap
Emerging Markets Equities
Global Equities, Large Cap
International Equities, Large Cap
Other:
Commodities
Hedge Funds
Index
DEX - 91-Day Treasury Bill
DEX – High Yield Bond
DEX – Universe, Real Return
Barclays Global Aggregate (C$)
DEX – Universe, Long Term
DEX – Universe
Correlation
0.04
0.37
0.47
0.51
0.70
0.77
S&P/TSX Capped Composite
S&P/TSX Capped REIT
BMO – Nesbitt Burns Small Cap Weighted
Russell 2000 (C$)
S&P 500 (C$)
MSCI – Emerging Markets (C$)
MSCI - World (C$)
MSCI – EAFE (C$)
-0.15
-0.06
-0.06
0.00
0.05
0.07
0.09
0.15
S&P GSCI Commodity (C$)
CSFB/Tremont Hedge Fund (C$)
-0.28
0.16
Data source: Aon Hewitt Investment Consulting
Commercial mortgages also offer a higher level of security than alternative fixed income products.
The security behind the majority of bond issues relies on the good faith and credit of the issuer. In
the event of a default, bond indentures do not entitle the lender to attach a claim to a specific asset
owned by the borrower. Bondholders are considered general creditors, ranking in priority just ahead
of common stock holders. Recovering on general creditor debt is dependent upon the liquidated
value of the borrowing entity after all of the secured creditors (including mortgage holders) have
been satisfied.
Mortgage lenders, on the other hand, hold a priority charge against specific fixed assets. In the case
of a default on a mortgage loan, the lender may look to the Borrower as well as the property and its
cashflow for repayment. The lender may use several mortgage default remedies including
foreclosure and power of sale to maximize the likelihood of recovering the full amount of the
outstanding loan.
Why Mortgages: An Investment Comparison
© 2012 ACM Advisors Ltd.
Page 9 of 11
Superior risk-adjusted returns, low volatility, portfolio diversifying effects and tangible real property
security are primary benefits of an investment in commercial mortgages. While market volatility
resulted in wider credit spreads in 2009, credit spreads are now near normal historical levels using
conservative loan covenants. Given the strong and sound real estate fundamentals in Canada,
excellent investment opportunities continue to exist for investors through an experienced
commercial mortgage fund manager.
ACM Advisors Ltd. is a fixed income management firm with over $1.15 billion of assets under
management. Specializing in pooled commercial mortgage funds and related real estate debt
products, ACM Advisors Ltd. is a recognized leader in this asset class with all three of its mortgage
funds, Mortgage Fund One, Mortgage Fund Two and the ACM Commercial Mortgage Fund, having
attained rankings in the top percentile among mortgage funds in Canada over 1, 2, 3, 4 and 10 years
as reported in the RBC Dexia Pooled Fund Survey dated December 31, 2011.
1 Year Returns
2 Year Returns
3 Year Returns
4 Year Returns
10 Year Returns
Why Mortgages: An Investment Comparison
© 2012 ACM Advisors Ltd.
1. Mortgage Fund Two
1. Mortgage Fund Two
1. Mortgage Fund Two
1. ACM Commercial Mortgage Fund
1. Mortgage Fund One
Page 10 of 11
For further information on any of our funds, please contact Lezlie Mintz, Director – Business
Development, at 604-661-0671.
Important information about the Fund is contained in the offering memorandum, including a detailed description of the Fund's investment objectives,
investment strategies and risk factors. This document has been prepared for information purposes only and should not be construed as a solicitation
for, or offering of, an investment in securities in any jurisdiction where such offer or solicitation would be prohibited. The Fund is an exempt market
security; prospective investors are advised to read the offering documents and to consult with an independent financial advisor prior to making any
investment decision based on this document. Minimum investment varies by province. The indicated rates of return are the historical compounded
total returns including changes in unit value and reinvestment of all distributions and do not take into account sales, redemptions, distributions or
optional charges or income taxes payable by any Unitholder that would have reduced returns. Compounded returns are annualized for periods greater
than one year. The rates of return shown in this document are used only to illustrate the effects of the compounded growth rate and are not intended
to reflect future value of the Fund or future returns on investment in the Fund. The Management Expense Ratio (“MER”) is annualized.
Commissions, trailer fees, management fees and expenses all may be associated with mutual fund investments. Mutual fund securities are not covered
by the Canada Deposit Insurance Corporation or by any other government deposit insurer. Please read the offering documents before investing. The
current distribution represents the annualized compounded current distribution of the Fund, divided by the current Net Asset Value ("NAV") of the
Fund. Please note that the current distribution may not be available at the time of purchase due to fluctuations in the current distribution amount
and/or the NAV. Information, opinions and statistical data contained herein were obtained or derived from noted sources believed to be reliable at the
time of this publication; however, ACM Advisors Ltd. does not represent that any such information, opinions or statistical data is accurate or
complete, and they should not be relied upon as such. ACM Advisors Ltd. endeavors to provide accurate information throughout this document, but
errors may occur and information and documents may become out of date. ACM Advisors Ltd. does not guarantee the accuracy, completeness, or
timeliness of the information and documents.
Why Mortgages: An Investment Comparison
© 2012 ACM Advisors Ltd.
Page 11 of 11