Higher yielding assets are benefiting from the Federal Reserve’s lower for longer policy on interest rates, a policy that many market participants believe will be extended in the wake of Donald Trump’s victory in last week’s presidential election.
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.
If the Fed decides to hike rates, mREITs will be pressured. 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.
Specific corners of the lineups in MORT and REM look particularly well-positioned to deliver for income investors.
“With the majority of portfolios consisting of floating-rate loans, commercial mortgage REITs stand to benefit as rates move upward,” according to a note from FBR & Co. posted by Amey Stone of Barron’s.
“Deregulation at the bank level could be perceived to be a negative for mREITs, but we believe our “CRE thesis” remains intact as the [Office of the Comptroller of the Currency] OCC will continue to keep an eye on CRE lending, leaving plenty of runway for the mREITs to originate loans without sacrificing credit. On the residential side, higher rates negatively affect RMBS portfolios, but we believe our companies are well hedged against higher rates, which should protect book value.”
MORT and REM, like other REIT assets become more attractive when yields on other fixed-income assets are pushed down. On the bright side for REM and its investors is the fact that the ETF’s dividend is expected to rise for the first time since 2014.
The VanEck Vectors Mortgage REIT Income ETF has a trailing 12-month dividend yield of 8.31%.
“Mortgage REITs may potentially stand to benefit from the evolving mortgage finance market but are sensitive to interest rate and regulatory changes,” according to VanEck.
VanEck Vectors Mortgage REIT Income ETF (NYSEArca: MORT)