Tempting Mortgage REIT ETFs

The past year has not been kind to exchange traded funds holding mortgage real estate investment trusts, or mREITs. Over that period, the iShares Mortgage Real Estate Capped ETF (NYSEArca: REM) and the rival Market Vectors Mortgage REIT Income ETF (NYSEArca: MORT) are down an average of 17%.

MORT and REM currently sport an average trailing 12-month dividend yield of about 13%, so it is understandable that these ETFs tempt yield seekers. However, it is widely believed that these ETFs and their holdings are vulnerable to rising interest rates.

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. [mREIT Opportunity]

Though mREITs’ negative relationship to interest rates is widely known, that is not preventing some analysts from making bullish calls on the group.

“The economic return performance has been weak in 2015 and the outlook for 2016 remains challenging. However, with the sector already trading at a 25% discount to book, we see many of the risks as already being reflected in the valuation. As a result, we feel the mREITs present an attractive risk/reward. That being said, we don’t see any clear catalysts to drive increased valuation and expect the majority of the return to come from the 14.7% dividend yield,” according to a Credit Suisse note posted by Amey Stone of Barron’s.