Mulling Mortgage-Backed Securities ETFs

With the Federal Reserve continuing its efforts to normalize U.S. monetary policy, plenty of asset classes could be affected by those plans, including mortgage-backed securities (MBS) and exchange traded funds such as the iShares MBS ETF (NYSEArca: MBB).

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.

The $12.12 billion MBB, which is more than 11 years old, “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.

Reasons To Consider MBB

“The fixed income market remains challenging, but market technicals have improved as demand from banks and others has absorbed the increased supply as the Federal Reserve (Fed) normalizes its balance sheet,” said BlackRock in a recent note. “The key is being selective: We think mortgage-backed security valuations remain attractive and prefer agency MBS over credit, TIPS over Treasuries and investment grade over high yield within credit.”

Related: Emerging Markets Multi-Sector Bond Outlook