I’m retired and I’ve structured my portfolio to focus on income rather than growth. I am interested in your opinion of Capital Direct I Income Trust.
Capital Direct I Income Trust is a pooled investment fund that aims to deliver steady income to unitholders by holding a portfolio of residential mortgages in British Columbia, Alberta, Ontario and Atlantic Canada. Unlike a mutual fund, however, the trust has redemption restrictions and other risks that investors need to understand before taking the plunge.
Thanks to the relatively buoyant housing market, the trust has performed reasonably well. According to the most recent fund fact sheet, the class A and class C units both returned about 8.8 per cent for the year ended June 30, with five-year annualized returns of about 7.1 per cent and 7.3 per cent, respectively. (The class F units, which are intended for fee-based accounts, have posted slightly higher returns because they charge a reduced management fee of 1 per cent, compared with 2 per cent for the class A and class C units.)
However, the trust’s performance is less impressive when compared with the S&P/TSX Composite Index TXCX, which posted a five-year annualized total return (including dividends) of about 15 per cent over the same period. The difference is perhaps not surprising, given that the benchmark index holds a diversified basket of companies that generate both growth and income, while the trust is primarily an income-generating vehicle.
I don’t have a crystal ball, but if Canada’s economy and real estate market hold up well in coming years, the trust will likely continue to deliver decent returns. However, if we have a recession that is accompanied by sharply falling home prices and sustained job losses, the trust could feel some pain.
Potential investors need to be especially mindful of such economic risks, given that Capital Direct’s lending arm serves many borrowers – such as self-employed individuals and people with less-than-pristine credit scores – who may not qualify for traditional bank financing.
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Adding to the risk, only about 60 per cent of Capital Direct’s loans are first mortgages, with second mortgages accounting for 38 per cent of its portfolio and third mortgages making up the remaining 2 per cent. So, in 40 per cent of cases, Capital Direct will be second or third in line behind other lenders should the borrower default because of a job loss, illness or other unforeseen event.
These factors are reflected in the relatively high interest rates Capital Direct charges borrowers. According to an offering memorandum available on the trust’s website, the weighted average interest rate of its mortgages is 11 per cent. To help control risk, all the trust’s mortgages have a term of two years or less.
Lack of liquidity is another consideration for investors. Unlike units of a mutual fund or exchange-traded fund, Capital Direct’s units cannot be redeemed or sold on demand. Rather, they are redeemable by the trust only on the last business day of every month, with at least 21 days’ notice.
Moreover, the offering memorandum says that “any retraction of class A units prior to the fifth anniversary of the issue of the class A units, and any retraction of class C units or class F Units prior to the 180th day from the issue of the class C units or class F units, will be at a discount to their net asset value per unit,” which is intended to be stable at $10. As such, “this investment may not be suitable for investors who will require short term liquidity,” the memorandum says.
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There are other potential costs to keep in mind: If a unitholder makes more than one retraction in a calendar year, a $65 “handling fee” will apply to the second and subsequent redemptions.
In a severe economic downturn, investors could potentially face even more restrictions on getting their money out. The offering memorandum states that “the obligation of the trust to retract units will be subject to the manager determining in its sole discretion, acting reasonably, that sufficient funds are available to the trust for the purposes of retraction.”
On any given monthly retraction date, the trust will limit redemptions to 0.833 per cent of the net asset value of the portfolio (or 10 per cent on an annualized basis), unless the manager decides otherwise, the memorandum says. If redemption requests exceed that threshold, which could happen if investors get nervous and try to withdraw their money all at once, the trust will prorate redemptions so as not to exceed the cap. This is one of the drawbacks of owning an investment for which there is no liquid secondary market, and it’s a key consideration for anyone considering the units.
My advice is to read the offering memorandum and marketing materials carefully and decide if you’re comfortable with the risks and rewards of investing in the residential mortgages offered by Capital Direct. You’ll probably do fine as long as the economy and housing market don’t do a face plant, but if things get bad out there, it’s hard to see how the trust would escape unscathed.
E-mail your questions to jheinzl@globeandmail.com. I’m not able to respond personally to e-mails but I choose certain questions to answer in my column.