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Why MICs are an effective portfolio diversification tool

8 December 2022

All investors know that diversification is essential to long-term financial success.  By investing in multiple asset types, you balance out risk and return, creating more stability and avoiding extreme highs and lows. Trying to time the market and pick a “winner” usually results in losses – and high levels of stress and anxiety.  

But today, the standard diversified 60/40 portfolio of stocks and bonds may not be enough to generate the returns you need. According to the Bank of America, 60/40 portfolios are facing the worst returns in 100 years. And, with Canada’s inflation rate at 7–15%, depending on the calculation method, your investments have to generate at least that amount for you to achieve a positive return and maintain the purchasing power of your savings. That’s why many investors today consider alternative investments to be crucial components of a well-diversified portfolio. 

Mortgages are one of the fastest growing segments within alternative investments, providing investors with steady cash flow, exposure to real estate without the risk of homeownership and broader diversification benefits beyond just stocks and bonds. Mortgage investments also satisfy one of the core tenants of diversification: low correlation with public markets. Within this category, Mortgage Investment Corporations, or MICs, are one of the easiest ways to participate directly in Canada’s mortgage market – and gain indirect exposure to the country’s historically strong real estate market. 

MICs – a diversified investment choice

With low correlation to stocks, bonds and other public markets, MICs are a compelling portfolio diversification tool.  A MIC pools capital from several investors and then lends these funds out as private mortgages. In this way, MICs are like mutual funds, but instead of stocks and bonds as the underlying assets, the funds are made up of carefully curated mortgages. Investors who deposit money into a MIC become preferred shareholders. The MIC makes money by collecting interest and fees from the borrowers. These fees are then passed on to shareholders in the form of dividend payments, which are typically monthly. 

 

MICs are diversified in multiple ways, so not only is the overall investment a diversified choice from traditional stocks and bonds, but each individual MIC is diversified across several criteria:

  • Loan-to-value (LTV):

     The loan-to-value ratio compares the size of the mortgage loan to the value of the property. For example, if the property is worth $500,000 and the mortgage is $400,000, you have an LTV ratio of 80%. Generally speaking, the higher the LTV, the higher the risk for the lender – but also the higher potential yield as the rates to borrowers tend to be higher.  A well managed MIC will seek to balance the risk/return profile to generate consistent yields for its investors.

  • Geography:

    MICs seek to diversify their holdings by investing across a broad geography. Some concentrate on a single region or province, while others invest nationwide. MICs can further diversify by urban, suburban or rural locations, in fast-growing regions or traditionally strong city centres, such as Toronto and Vancouver.

  • Borrower:

    All borrowers undergo rigorous vetting.. Things like credit score, income and debt levels are all important considerations in determining whether they will make their mortgage payments.  This helps mitigate the risk of default to investors. 

  • Type of investment:

    Canada’s Income Tax Act mandates that MICs must invest 50% of their assets in residential mortgages and the remainder can be invested in commercial mortgages or construction loans. At CMI,  our MICs are invested almost entirely in residential mortgages which we believe offer the most attractive risk/return profile. 

  • Length of mortgage:

    Private mortgages have terms lasting  6 – 36 months, with 12 months being the standard. 

  • Type of mortgage:

    MICs can invest in first, second or even third mortgages. A first mortgage is the primary, or initial loan on the property. A second mortgage is subordinate to the first, which means that in the event of default, the first mortgage will get priority in terms of repayment. Mortgages are backed by the underlying property.

  • Management style:

     As private lenders, MICs can have very different management styles. Some prefer to focus on higher risk, higher yield loans to repeat borrowers. Others use a more balanced approach and may have a single individual or a team of highly experienced investment professionals managing the overall MIC portfolio.

  • # Shareholders:

    MICs must have a minimum of 20 shareholders, and no one shareholder may own 25% or more of a MIC’s issued shares.This helps to minimize the risk to all shareholders should any borrower default. At CMI, we’re proud to have a historical loan loss rate below 1%.

There are many ways in which a MIC can diversify its holdings to mitigate risk while producing an attractive yield to investors. At CMI, our MIC funds have historically returned between 6 – 11%, making them an attractive, diversified alternative investment choice, especially when compared to a 10-year Canada bond which currently yields an average return of just 2.0%.

Learn more about CMI MIC Funds. Get direct exposure to Canada’s mortgage market. Explore high-yield fixed income alternatives backed by residential real estate.

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