As Fed Looks to Taper Mortgage Purchases, Get Targeted Duration With 'MBSD'

It’s difficult to price uncertainty into an exchange-traded fund (ETF) product, but with interest rates at the whim of the Federal Reserve, it helps to get targeted duration with the FlexShares Disciplined Duration MBS Index Fund (MBSD).

To taper or not to taper will be the question as the Federal Reserve mulls over what to do with purchases of mortgage-backed securities. In the meantime, targeted duration can help ease some of the uncertainty with the Fed’s next moves.

“The debate — over whether to taper the Fed’s purchases of mortgage-backed securities faster than its buying of Treasury debt — will probably be near the top of the agenda when officials gather July 27-28 to discuss next steps for policy,” a Bloomberg article reported.

MBSD seeks investment results that generally correspond to the price and yield performance of the ICE BofA Merrill Lynch, Constrained Duration US Mortgage-Backed Securities Index.

The underlying index reflects the performance of a selection of investment-grade U.S. agency residential mortgage-backed pass-through securities. The fund generally will invest under normal circumstances at least 80% of its total assets (exclusive of collateral held from securities lending) in the securities of the underlying index and in “TBA Transactions” representing securities in the underlying index.

“The index is composed of securities selected from the universe of 10-year, 15-year, and 30-year MBS,” the Fund Focus added. “The index seeks to maintain a monthly effective duration within a one-year band of 3.25 years to 4.25 years—with a midpoint target of 3.75 years. This range was chosen to help avoid greater turnover than potentially necessary to help maintain the target duration. The index also factors such as current Federal Reserve policy, the outlook for U.S. interest rates and potential reforms of agency mortgage programs.”

An Income Solution

In addition, the current low-rate environment can be ameliorated with assets like mortgage-backed securities as an income source.

“Many investors look to mortgage-backed securities (MBS) as an option to help diversify their fixed-income holdings and pursue higher potential yields than are available from U.S. Treasuries,” a FlexShares Fund Focus article said. “However, investing in MBS comes with special considerations around duration—a key measurement of a fixed-income security’s sensitivity to interest rate movements.”

“We believe that historically duration has been a major driver of MBS risk and returns and that investors must continually monitor the effective duration of an MBS portfolio due to the impact of mortgage prepayments,” FlexShares added.

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