ETFs that invest in mortgage REITs are throwing off income of more than 10% but investors need to be aware of the risks before chasing those juicy yields, such as the threat of rising interest rates and the dangers associated with leverage.
The $537.4 million iShares FTSE NAREIT Mortgage Plus Capped Index Fund (NYSEArca: REM) has a 30-day SEC yield of 13.3%, according to sponsor BlackRock.
Meanwhile, the $51.5 million Market Vectors Mortgage REIT Income ETF (NYSEArca: MORT) sports a 30-day SEC yield of 12.2%, according to manager Van Eck.
Real estate investment trusts, or REITs, are companies that distribute most of their profits to shareholders in the form of dividends to qualify for government tax breaks. [ETF Spotlight: Mortgage REITs]
“This ETF’s portfolio is composed of mortgage REITs, which are firms that seek to benefit from the spread between short-term and long-term rates by using very short-term debt such as repurchase agreements to fund purchases of residential and commercial mortgage-backed securities,” says Morningstar’s Patricia Oey in an analyst report on MORT.
The use of leverage boosts the ETFs’ yield but also creates risks.
REM has an expense ratio of 0.48% while MORT charges 0.4%.
“At this time, mortgage REITs are benefiting from historically low short-term rates, but tightening spreads, or a sudden freeze in the credit markets, would have a significant negative impact on these firms. Also, a decline in the value of a REIT’s portfolio due to rising interest rates would give lenders the right to make margin calls, which could force these REITs to sell securities to raise additional collateral,” Oey wrote.
MORT has delivered a total return of 21.1% year to date, compared with 21.6% for REM.
“Given that the underlying investments in this ETF are mortgage-backed securities, investors in this ETF are exposed to credit risk and prepayment risk,” according to the Morningstar report on MORT. “While most residential mortgage backed securities are currently backed by Freddie Mac and Ginnie Mae, the gradual withdrawal of these agencies from the mortgage-backed market will raise the credit risk of this ETF. Another source of ‘government risk’ is the possibility of legislation to lower the hurdles for refinancing would significantly raise the risk of prepayment.”
iShares FTSE NAREIT Mortgage Plus Capped Index Fund