Charlie Munger put it better than anyone: "Show me the incentive and I'll show you the outcome."
In a private mortgage fund, the manager is the asset. You are not really buying a loan. You are buying that manager's judgement about which loans to write, how to value the security, and what to do when a borrower stops paying.
The headline return tells you almost nothing about any of that. These are the questions that do.
Does the manager have its own money in the deal, and where does it rank?
This is the first question, and for most managers it is the one that ends the conversation.
Plenty of managers earn fees whether your capital performs or not. They originate the loan, take an establishment fee, clip an ongoing margin, and move on. Their incentive is volume, not outcome. If the loan goes bad, it is your capital that absorbs it.
The structure you want to see is one where the manager's own money is in the deal and ranks behind yours. In the SL Premium Income Fund, investor capital is exposed to roughly a 65% loan-to-value ratio, and the manager funds the slice above that, sitting in a first-loss position. If the security has to be sold and there is a shortfall, the manager's capital is wiped out before yours is touched.
That is not a marketing line. It is a structural fact that changes the manager's incentive on every single loan they write. They cannot afford to underwrite badly, because they lose first.
Ask directly. Is your capital in this deal? Where does it rank relative to mine? If the answer is vague, you have your answer.
Who gets repaid first if a loan goes bad?
Follow the waterfall. When a loan defaults and the security is sold, the proceeds are distributed in a set order. You want to know exactly where you sit in that order: ahead of the manager, ahead of any subordinated capital, and secured by a claim that ranks ahead of other creditors.
A clear, written repayment waterfall is a sign of a manager who has thought about the downside. A hand-wave is a sign of one who has not.
Is the loan secured by a registered first mortgage, or something weaker?
Not all security is equal.
- •A registered first mortgage puts the fund first in line against the property.
- •A second mortgage sits behind whoever holds the first, and only sees proceeds after the first mortgage is repaid in full.
- •A caveat is weaker still. It is faster and cheaper to lodge, but it does not give the lender the same enforcement rights as a registered mortgage.
Higher-yielding funds often achieve that yield by taking weaker security. That can be a legitimate trade if you understand it and you are paid for it. It is not legitimate if it is buried and you think you are buying senior risk. Ask what ranking the fund holds on every loan, not just in general. Our guide to first mortgage investment funds explains why the ranking does so much of the work.
How is the security valued, and by whom?
The loan-to-value ratio is only as good as the valuation underneath it. Two questions matter here.
First, is the valuation independent? A manager valuing its own security has an incentive to be generous. You want valuations from qualified, independent valuers with no stake in the loan proceeding.
Second, what basis is the valuation on? An "as-is" valuation reflects what the property is worth today. An "as-if-complete" valuation reflects what it will be worth once a construction or development project is finished, which assumes the project actually gets finished, on budget, on time. A 65% loan-to-value ratio against an as-if-complete valuation of a half-built project is not the same risk as 65% against a completed, income-producing building. Know which one you are looking at.
What is the real loan-to-value ratio, and against what value?
Managers can make an LVR look conservative by valuing the security optimistically, or by quoting the ratio against a peak-of-market figure.
Push on it. What is the current, independent, as-is value? What is the loan as a percentage of that? What buffer does that leave to absorb a fall in value, plus the costs and accrued interest of an enforcement, before your capital is at risk?
The gap between the loan and a conservative current value is your margin of safety. Everything else is commentary.
What is the track record, through a downturn, not just a boom?
Anyone can lend money in a rising market. The loans that test a manager are the ones written into a softening one, and the defaults that test them are the ones worked out when values are falling.
Ask how long the manager has been operating, how much they have funded, and, more importantly, what has actually happened when loans have gone wrong. A manager who has never had a default has either been extraordinarily lucky or has not been going long enough to tell you anything.
What happens when a borrower stops paying?
Origination is the easy part. Recovery is where capital is preserved or lost. A good manager has a clear, practised process:
- •How they identify arrears early
- •How they engage the borrower
- •When and how they appoint a receiver or agent
- •How they run a sale to maximise recovery rather than dump the asset
This is where in-house expertise matters enormously. A manager with genuine insolvency and recovery experience on the team, people who have actually enforced security and worked out distressed positions, will recover more, and faster, than one who has to outsource the moment a loan goes bad.
Ask who handles a default and what they have done before.
Is it contributory or pooled, and can you see the actual loan?
In a contributory (sub-trust) structure, each investment sits against a single, identified loan. You can see the security, the borrower's purpose, the LVR, the term, and the exit before you commit. In a pooled fund, your money is spread across a book of loans you may never see individually.
Neither is automatically better. Pooling spreads risk across many loans, while a contributory structure gives you transparency and deal-by-deal choice. What matters is that you know which one you are in and that the disclosure matches the structure. Be wary of any pooled fund that will not tell you what is actually in the pool.
Is the loan self-liquidating, with a defined exit?
A well-structured loan repays itself on a known timeline through a defined exit, a refinance or a sale, usually inside twelve months. That is very different from an open-ended facility with no clear repayment path.
A defined, credible exit is the difference between a loan and a hope. Ask what the exit is on every loan, and whether it is realistic.
Who is actually running it, and have they done this before?
Finally, look at the people. Named individuals, with real credentials, who have done this specific work through a cycle:
- •Property valuation expertise
- •Credit and financing experience
- •Insolvency and recovery capability
A private mortgage fund is an operating business, not a passive product, and it lives or dies on the quality of the people underwriting and enforcing the loans. If you cannot find out who they are or what they have done, that is a finding in itself.
The bottom line
Return is an output. It is a function of who is underwriting the loans, how the security is structured, and what happens when things go wrong.
Assess the manager properly and the return looks after itself. Assess only the return, and you are trusting a number without knowing what is behind it.
FAQs
Why does it matter whether the manager has its own capital in the deal?
Because it changes what happens to them when a loan goes bad. A manager paid on origination volume is fine either way. A manager holding a first-loss position loses their own money before yours is touched, which disciplines every underwriting decision they make.
What is a first-loss position?
It means the manager's capital absorbs the first portion of any shortfall on a sale. In the SL Premium Income Fund, investor capital is exposed to roughly a 65% loan-to-value ratio and the manager funds the slice above that, so a shortfall hits the manager before it reaches investors.
What is the difference between an as-is and an as-if-complete valuation?
An as-is valuation is what the property is worth today. An as-if-complete valuation is what it will be worth once a development is finished, which assumes the project completes on budget and on time. The same LVR against each represents very different risk.
Is a higher target return a warning sign?
Not on its own, but it always has a source. Often that source is weaker security, a higher LVR, a longer or undefined term, or a development risk. A higher return is only a problem when you have not been told which of those you are being paid for.
How long a track record should a manager have?
Long enough to have written loans into a softening market and worked out defaults in one. A manager with no defaults has either been lucky or has not been operating long enough for the record to mean anything.
Can I see the individual loan before I invest?
In a contributory structure, yes. Each investment sits in its own sub-trust against a single identified loan, so you can review the security, purpose, LVR, term and exit before committing. In a pooled fund you generally cannot.
Invest with the SL Premium Income Fund
For wholesale and sophisticated investors, our private mortgage investment fund, the SL Premium Income Fund, is built around the structure described above. You can read more about the first mortgage income that secures every loan, how the fund gives exposure to alternative real estate debt, or read our guide to private mortgage funds in Australia. If you are investing through a self-managed super fund, start with what trustees need to know.
This article is general information only and does not constitute financial, tax, or legal advice, and does not take account of your objectives, financial situation, or needs. The SL Premium Income Fund is an unregistered managed investment scheme available only to wholesale and sophisticated investors within the meaning of the Corporations Act 2001, and is not suitable for retail clients. It is issued by SL Premium Income Fund Pty Limited (ACN 664 382 076, AFSL 549857) as trustee. Target returns are not guaranteed, past performance is not indicative of future returns, and investment carries risk including the possible loss of capital. Read the Information Memorandum in full and seek independent advice before investing.
