With mortgage rates at the highest levels in decades, it’s reasonable to expect new mortgage applications will decline, but that doesn’t mean fixed income investors should carry negative sentiment toward mortgage-backed securities (MBS).
MBS are one of the largest corners of the bond market, accounting for nearly a quarter of the U.S. and 12% of the global fixed income space. Registered investment advisors and investors of all stripes can efficiently access baskets of MBS thanks to exchange traded funds such as the WisdomTree Mortgage Plus Bond Fund (NYSEArca: MTGP).
The actively managed MTGP debuted nearly four years ago and invests in commercial and residential mortgage bonds. Indeed, there is some interest rate sensitivity with this asset class as highlighted by rising MBS yields on the back of surging Treasury yields. However, MTGP has avenues for compensating investors for that rate risk.
MTGP Benefits
MTGP sports an embedded income yield of 5.97%, which alone is attractive, but the WisdomTree ETF also offers investors the benefit of strong credit quality.
“We believe that high credit quality, high liquidity, and high coupon income offer investors an attractive opportunity with effectively (and historically) no or only little credit risk,” noted John Carey of BNP Paribas. “Looking at spreads over other classes of fixed income, we expect corporate bond spreads to widen materially over the next 6-8 months as the economy slows and issuers feel the pinch. Even if mortgage bond spreads stay unchanged, the carry alone should allow agency MBS to outperform other spread sectors.”
Another reason to consider MTGP is that, as Carey noted, many of the headwinds that confounded MBS investors earlier this year are improving. Those include asset sales by financially weak regional banks, weak supply, and an uptick in MBS market volatility. With the broader MBS climate showing incremental signs of improvement, now could be an appropriate time for advisors to consider this segment of the bond market.
“We believe global financial conditions and the prospects for investors in the asset class are more appealing now than they have been for several years. We see current entry yields as the most attractive since the Great Financial Crisis and believe this bodes well for future returns,” added Carey.
BNP recommends an “overweight” view on MBS relative to Treasuries. MTGP holds 120 securities with its largest component commanding 9.68% of the fund’s roster. The ETF has an effective duration of 5.97 years.
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