For fixed income investors looking for value, mortgage-backed securities (MBS) could be a potential opportunity despite rising interest rates and diminishing demand for housing could provide more headwinds in the long-term forecast.
A marked decrease in refinancing due to higher mortgage rates also provided additional headwinds. As such, MBS assets of the government-backed variety didn’t fare as well as their other debt peers.
“Government-backed mortgages underperformed Treasuries over the second quarter as spreads widened,” Vanguard noted in its latest fixed income perspective. “Higher interest rates and worries about the Fed’s plans to reduce its mortgage-backed securities (MBS) holdings drove the selling.”
However, Vanguard noted they’re more optimistic regarding MBS assets.
“We are more optimistic,” Vanguard said. “While there is precedent in prior tightening cycles for the Fed to slowly wind down its MBS balance sheet, active sales of MBS by the Fed would be unprecedented and are unlikely.”
As mentioned, mortgage rates “have jumped, considerably lowering the amount of outstanding mortgage debt eligible for refinancing. We expect the Fed’s ability to shrink its MBS holdings will be well below its stated pace of $35 billion per month through the end of the year, which is a positive for the sector.”
Where to Get MBS Exposure
Whether as a value play or a fixed income diversification tool, one fund to consider is the Vanguard Mortgage-Backed Securities Index Fund ETF Shares (VMBS). The fund comes with a low expense ratio of 0.04% as well as a 30-day SEC yield of 2.31% as of August 4.
Even as rates tick higher, VMBS can also rise in tandem since it derives its income from higher rates on 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.