Average returns for tax-lien funds aren't available, GFI's McOsker said. A diversified portfolio of "quality" assets, meaning liens that redeem before the waiting period is over and before the buyer may foreclose, could return about 6 percent to 9 percent annually, he said. Most tax-lien funds sell shares directly to investors, rather than going through a broker- dealer, he said.
The tax treatment of profits and losses on tax-lien investments varies, depending on several factors, said Eric Smith, a spokesman for the U.S. Internal Revenue Service.
Investors may be better off buying shares in certain bond mutual funds that invest in mortgage debt, such as DoubleLine Total Return Bond Fund, said Zafran of Luminous Capital, which manages about $4.7 billion for individuals and families, and doesn't own tax liens.
The DoubleLine fund had about 83 percent of assets in mortgage-related securities as of December, according to the fund's website. It returned 9.2 percent in 2011, according to data compiled by Bloomberg. High-yield corporate bonds, or those rated below investment grade, returned about 4.4 percent in 2011, as measured by the Bank of America Merrill Lynch U.S. High Yield Master II Index, Bloomberg data show.
"You have limitations on when and if you can pull your capital" from a private fund, Zafran said. "And you're going to be subjecting yourself to a high set of fees."
Finkelstein, 52, who traded bonds and derivatives for 15 years prior to starting his company, now manages private placements that invest in the liens. When buying into one of Finkelstein's funds, investors generally must commit to locking up their money for a certain period of time, such as one year. After that point the funds begin to distribute cash to investors as liens are paid off, a process that may take about 1 1/2 years to complete, Finkelstein said. Because the funds don't liquidate until the last lien or foreclosure in the portfolio is paid off or resolved, there's no precise certainty as to when investors will get all of their cash back.
Accredited Investors
Finkelstein said after fees, which are 2 percent annually plus 20 percent of gains, one of the funds he manages returned about 8 percent in 2010. Returns aren't yet available for 2011 and as of Aug. 1 the fund was on track to earn about 7 percent for the year, he said. The funds are available only to accredited investors, which generally means individuals with assets of greater than $1 million, excluding a primary residence, or earning more than $200,000 annually.
Finkelstein invests primarily in New Jersey and said he mostly buys liens on single-family homes in more affluent areas, where he said the certificates are backed by stronger collateral and there's less of a chance a lien will go to foreclosure.
"More than 99 percent of the time the bank will pay you off," rather than allow a foreclosure to proceed, if a homeowner hasn't paid the taxes and the property hasn't dramatically depreciated, he said. That's because the lien can wipe out a mortgage of greater value.