Counter Inflationary Pressure with Mortgage-Backed Securities, 'MBSD'

As inflationary pressure continues to push higher, fixed income investors can fight back with exchange traded funds (ETFs) like the FlexShares Disciplined Duration MBS Index Fund (MBSD).

“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.

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

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” that represent 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 in an effort 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.”

Are Rates Moving Higher?

Mortgage-backed securities can certainly benefit if rates continue to push higher. Per a Money article, rates rose “for the second day in a row” and the “30-year fixed-rate mortgage increased to 3.38% on average, climbing 0.029 percentage points from yesterday.”

These fluctuations can be a challenging aspect of mortgage-backed securities, but nonetheless, still provide diversification in income.

“An allocation to the MBS segment may help investors diversify their fixed-income holdings with bonds that offer strong credit quality and attractive yields,” the FlexShares Fund Focus added. “However, managing duration positioning in an MBS portfolio can be challenging, as changes in interest rates also can lead to changes in mortgage prepayment levels that may move MBS duration more dramatically than expected.”

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