While the Federal Reserve appears set to raise interest rates later this month, higher yielding assets have come under some pressure.
That group includes the iShares Mortgage Real Estate Capped ETF (NYSEArca: REM) and the rival VanEck Vectors Mortgage REIT Income ETF (NYSEArca: MORT), which hold mortgage real estate investment trusts, or mREITs.
Mortgage REITs have exhibited a negative correlation to interest rates changes, especially if the yield curve flattens. Many agencies use leverage to capitalize on the arbitrage spread between short- and long-term interest rates, so companies can still make money in a rising rate environment, as long as long-term rates rise faster than the short-term rate or if the yield curve steepens.
However, income investors should not be hasty in abandoning rate-sensitive mREITs even if the Fed moves forward with boosting borrowing costs.
Mortgage REITs rely on short-term loans, so costs could rise if short-term rates suddenly spike. However, the negative effect of higher short-term rates could be somewhat offset by quickly rising long-term rates as mREITs benefit from a steeper yield curve and arbitrage the wider spread.