Amid a more sanguine outlook for U.S. interest rates this year, which is helping steady mortgage applications, investors are seeking lower risk, yield-driven strategies, including exchange traded funds with exposure to mortgage backed securities (MBS).
The iShares MBS ETF (NasdaqGM: MBB) is the largest MBS ETF in the U.S. MBB provides exposure to a broad range of U.S. mortgage-backed bonds, including those issued by government sponsored enterprises such as Ginnie Mae, Fannie Mae, and Freddie Mac. The strategy also gained increased coverage after Rob Kapito, BlackRock’s president and co-founder, highlighted the opportunity in mortgage-backed securities.
“The $15 billion iShares MBS ETF, or MBB, has taken in more than $3 billion this year, according to data compiled by Bloomberg. Buyers have added about $1.5 billion in February alone, putting it on track to be the largest month of inflows since the fund started in 2007,” reports Bloomberg.
Mulling MBB ETF
MBS are created when an entity acquires a bundle of mortgages and then sells the securities. Most MBS are seen as a “pass-through” security where the principal and interest payments are passed through the issuer to the investor.
MBB “seeks to track the investment results of an index composed of investment-grade mortgage-backed pass-through securities issued and/or guaranteed by U.S. government agencies,” according to iShares.
While MBS may offer modestly higher yields relative to U.S. Treasuries, the mortgage-backed bonds are exposed to prepayment risk – if rates dip before the security’s maturity, a homeowner can refinance debt, causing an investor to get back the principal early and reinvest it in a security with a lower yield.
MBB has 30-day SEC yield of 2.83% and an effective duration of just over four years.
“Agency mortgages are a sweet spot for investors willing to take on just a little bit more risk than offered by Treasuries, getting more yield than the government debt without the credit risk that goes alongside corporate bonds,” according to Bloomberg. “Securities backed by home loans have also benefited from the Federal Reserve’s decision to hold off on interest-rate increases, as higher borrowing costs discourage refinancing and increase the duration of these securities.”
Other MBS ETFs include the Vanguard Mortgage-Backed Securities Index ETF (NYSEArca: VMBS), SPDR Barclays Mortgage Backed Bond ETF (NYSEArca: MBG), iShares CMBS ETF (NYSEArca: CMBS), iShares Core GNMA Bond ETF (NYSEArca: GNMA), FlexShares Disciplined Duration MBS Index Fund (NasdaqGM: MBSD) and First Trust Low Duration Mortgage Opportunities ETF (NasdaqGM: LMBS).
For more information on the fixed-income space, visit our bond ETFs category.