Yup, last month the Bank of Canada just increased their prime rate for the first time in 18 months. Yup, the Canadian economy is growing and we can see the recession blur dissipating slowly. However, this situation is not  happening in the same fashion elsewhere on the planet. Plus, recent inflation stats show a slow return of inflation (1.4% and 1.8% without the resources) which is way below the 2% target fixed by the Bank of Canada.

All this to say that if you are waiting for high interest rates before you invest your money, this ain’t going to happen this year! So you are looking for an alternative? Why don’t you consider mortgage funds?

Money Market Funds Suck

As I just mentioned, the interest rate environment in Canada will stay pretty quiet for the upcoming months. Therefore, if you are leaning towards money market funds, you will barely get 1.20% (ING savings account) and it is going to be difficult to find better than this. Since inflation is at 1.4%, you are assured of a net negative yield.

Bond Funds Are Riskier

If you think that bond funds are better, read this article explaining why you will lose money buying bonds funds this year. They are riskier and they will be negatively affected to a great degree when interest rates start to climb.

Good Security – Higher Return

I like mortgage funds because they offer a high level of security. It is important to look at them carefully to make sure that you are not investing in some kind of leftover subprime mortgages from Florida . Overall, most Canadian mortgage funds will include Canadian mortgages (both conventional or insured by the CMHC).

Therefore, they have a great level of security while offering a higher return than government bonds or money market funds.

Better Diversification

Another great point about mortgage funds is their diversification. Again, it is very important to carefully read the composition of your mortgage fund but they usually incorporate a mix of:

1-    Conventional Mortgages (properties with more than 20% equity)

2-    Insured Mortgages (backed by CMHC or Genworth)

3-    Government Bonds (Federal and Provincial)

4-    And sometimes a few corporate bonds!

So it’s a great way to add diversification to your fixed income portfolio while not increasing its risk.

The secret Mortgage Fund Weapon: Duration!

In fact, the biggest advantage of mortgage funds compared to other bonds funds is its duration. What does duration mean? Since I don’t want to go into the full detail (it deserves a full post alone!), let’s just keep in mind that the longer the duration you have, the more volatile the funds will be when there is an interest rate policy change. Since mortgage funds managers can keep their duration quite short (down around 2 years), your portfolio won’t be affected too much if there is a sudden interest hike.

I’d say that this is probably the best reason to consider mortgage funds for your portfolio; because of its protection against interest rate fluctuations.

Where can I get these mortgage funds?

I’ve made a list of most of all the mortgage funds I was able to find with a history greater than 5 years so you can look at an interesting perspective:

Fund Name	3 Mth Ret	1 Yr Ret	Quart 2 Yr Ret	5 Yr Ret	15 Yr Ret	Legal Status	RRSP
CIBC WM Residential Mortgage CAD	-0.6	2.7		6.5	7.4
PH&N Short Term Bond & Mortgage D	-0.8	4.4	1	4.1	5.7	Trust	Yes
Educators Mortgage & Income	-0.4	3.7	2	3.6	5.5	Trust	Yes
HSBC Mortgage	0.1	2.7	1	3.5	4.8	Trust	Yes
TD Mortgage - I	-0.8	-0.1	2	3.4	4.6	Trust	Yes
National Bank Mortgage	-1.3	0.6	3	3.4	5.0	Trust	Yes
MD Bond & Mortgage	-0.7	1.9	2	3.3		Trust	Yes
CDA Bond & Mortgage (Fiera)	-0.7	2.3	1	3.2		Segreg	Yes
Scotia Mortgage Income	-0.7	0.1	3	3.0	4.5	Trust	Yes
Investors Mortgage & Short Term Income	-1.0	0.3	3	2.9	4.1	Trust	Yes
BMO Mortgage and Short-Term Income	-0.8	0.8	3	2.7	4.1	Trust	Yes
Great-West Life Mortgage (G) DSC	-0.4	6.0	3	2.7	5.0	Segreg	Yes
Great-West Life Mortgage (G) NL	-0.5	5.7	3	2.5	4.7	Segreg	Yes
London Life Mortgage (LC)	-1.0	1.0	1	2.5	4.4	Segreg	Yes
CI Signature Mortgage	0.2	2.5	3	2.2	3.8	Trust	Yes
Clarica SF CI Mortgage A	0.0	1.9	4	1.7		Segreg	Yes
Clarica SF CI Mortgage	0.0	1.8	3	1.6		Segreg	Yes
Peer Diversified Mortgage	-7.4	-13.2	3	1.3		Trust	Yes
ACM Commercial Mortgage	2.4	10.3	1			Trust	Yes
mortgage funds over 5 year	-0.8	2.0		3.1	4.8

Note: while I sound like a mortgage funds fan, I must say that this does not qualify as a recommendation to buy such a fund. A profound analysis of your personal situation and review of your portfolio is required before giving investment advice. Please don’t drink the koolaid and drive; do your own research

• Segregated funds: The High Price of Security
• Canadian Mortgage Rules To Change Says Flaherty
• Hedge funds… an absolute return vehicle?
• Top 40 Canadian Portfolio Managers – Is Your Money Invested In The Right Place?
• What Will Happen With Canadian Mortgage Rates in 2010?

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