Mortgage REIT ETFs Could Merit A Second Look | ETF Trends

Unloved for much of 2013, real estate investment trust, or REIT, related exchange traded funds are now looking quite cheap and offer robust yields.

Mortgage REITs now trade at a 20% discount to the book value of its underlying holdings, reports Lewis Braham for Bloomberg.

Michael Widner, a REIT analyst at KBW Bank, believes the sector could generate over 20% in returns this year as the discount is priced out, combined with REITs’ attractive yields.

However, many have been wary about diving into mREITs in a rising rate environment since bond prices, the underlying holdings, fall as rates rise.

David Cohen, manager of the Eudora Fund, though, argues that investors shouldn’t be too concerned about higher rates because mREITs utilize complex hedging strategies to limit rate risk. For instance, Annaly Capital Management Inc (NYSE: NLY) has hedged half of its portfolio.

“The management team is more seasoned than teams at most other mortgage REITs,” Cohen said in the article.

REITs generate cash by profiting on the spread between long-term rates and short-term rates. The companies borrow money on short-term rates and use the money to purchase long-term bonds, so they generate larger yields on wider spreads.

With the Fed keeping its short-term rates near zero while benchmark 10-year Treasury yields hover around 3%, the spread between the two is at about its widest in 35 years, Cohen said. Consequently, profit margins at mREITs could rise.