ETFs that invest in mortgage real estate investment trusts have seen volatility pick up in the wake of the Federal Reserve’s QE3 program that has the central bank pumping more liquidity into the mortgage market.

For example, iShares FTSE NAREIT Mortgage Plus Capped Index Fund (NYSEArca: REM) has bounced the past three days following a two-week slide. The $897 million ETF pays a 30-day SEC yield of 12.3%.

Mortgage REIT ETFs rallied leading up to the Fed’s QE announcement but have weakened in October. [ETF Chart of the Day: Mortgage REITs]

Market Vectors Mortgage REIT Income ETF (NYSEArca: MORT) is another option for this asset class. Morningstar analyst Patricia Oey said the ETF is “suitable as a satellite holding for investors who seek higher-yielding securities and who understand the leverage risks associated with mortgage REITs.” [Mortgage REIT ETFs Yielding Over 10%]

The firms 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, she explained.

“Through the use of leverage, these REITs have yields in the midteens. 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,” Oey wrote in an analyst report on MORT.

In September, the Fed said it would purchase more agency mortgage-backed securities at a rate of $40 billion a month.

Barron’s reports that the Fed’s QE3 has created some troubles for mortgage REITs, however.

“A rise in mortgage refinancings and bond prepayments, due to falling rates enabled by Fed policy and large Fed mortgage bond purchases, has left many agency mREITs such as Annaly Capital Management (NYSE: NLY) and American Capital Agency Corp. (NasdaqGS: AGNC) trading sharply lower than a month ago,” says Barron’s Michael Aneiro.

Those two stocks are the largest holdings in REM, the mortgage REIT fund, with a combined weighting of about 37%.

The Fed’s third round of quantitative easing has “pushed down bond yields, narrowed spreads and reduced homeowner borrowing costs — squeezing the firms’ earnings and dividends,” Bloomberg News reports. “The immediate challenge to mortgage REITs comes from a jump in homeowner refinancing driven by record rates. That will force the companies to write off the premiums they paid for bonds faster and reinvest at lesser yields.”

This week, UBS launched the ETRACS Monthly Pay 2xLeveraged Mortgage REIT ETN (NYSEArca: MORL). The exchange traded note is designed to provide 200% leverage to mortgage REITs.

iShares FTSE NAREIT Mortgage Plus Capped Index Fund

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