While the major news in the capital markets continues to be the Omicron variant, fixed income investors will also be eyeing the Federal Reserve. In the meantime, consider mortgage-backed securities (MBS) exposure.
Why MBS? As the Fed continues to wind down its stimulus operations and settle into a tighter monetary policy, the notion is that rates will head higher, which could benefit MBS.
The higher the rates, the more potential revenue from MBS. A dual effect is rising real estate prices, which don’t appear to be letting up anytime soon.
“In the coming week, the Federal Reserve could decide to speed up the end of its bond-buying program and signal that it expects to start hiking interest rates in 2022,” CNBC reports. “That is already widely anticipated by investors, ahead of the Fed’s meeting Tuesday and Wednesday. Strategists don’t expect much market reaction, unless the central bank’s messaging includes a surprise or its forecast for interest rate hikes is more aggressive than expected.”
Getting MBS Exposure in One ETF
One way to capture this potential upside in MBS is via exchange traded funds (ETFs) like the Vanguard Mortgage-Backed Securities Index Fund ETF Shares (VMBS). For the cost-conscious investor, this comes with a low expense ratio of 0.05%.
VMBS seeks to track the performance of a market-weighted mortgage-backed securities index. The fund employs an indexing investment approach designed to track the performance of the Bloomberg U.S. MBS Float Adjusted Index, which covers U.S. agency mortgage-backed pass-through securities.
To be included in the index, pool aggregates must have at least $250 million currently outstanding and a weighted average maturity of at least one year. All of the fund’s investments will be selected through the sampling process, and, under normal circumstances, at least 80% of the fund’s assets will be invested in bonds included in the index.
Even as rates tick higher, VMBS can also rise in tandem, since it derives its income from higher rates in mortgages. With debt holdings backed by the government, VMBS gives fixed income investors that extra layer of security.
Highlights of VMBS:
- Seeks to provide a moderate and sustainable level of current income.
- Invests primarily in U.S. agency mortgage-backed pass-through securities issued by Ginnie Mae (GNMA), Fannie Mae (FNMA), and Freddie Mac (FHLMC).
- Moderate interest rate risk, with a dollar-weighted average maturity of three to 10 years.
For more news, information, and strategy, visit the Fixed Income Channel.