After enduring overwhelming recessionary shocks, the U.S
mortgage finance industry has gradually started recovering.
Favorable economic data coming in domestically and from abroad has
resulted in an increase in corporate activities leading to higher
income and consumption in the U.S markets.
As the demand for residential and commercial real estates rises,
likewise mortgage financing companies are bound to see an increase
in their asset books in the near future (read
Time For A Commercial Real Estate ETF?
). While this is favorable for the overall economy, care has to be
taken in order to prevent another housing bubble like in 2008.
With stringent risk management principles in place (like the
ones in Basel I, II and III) and the complex-derivative instruments
relating to mortgage financing (Mortgage back securities,
Collateralized Debt Obligation, asset-backed securities etc.) being
highly regulated post-2008 debacle, the solvency and credit quality
of the mortgage financing companies and their loans have improved
immensely.
One of the major players in the mortgage finance industry is
Real Estate Investment Trusts (REITs)
. REITs are companies that finance, own and operate real estate
properties. They raise capital from retail as well as institutional
clients and pool the raised capital to purchase mortgage securities
from the market. The returns thus generated from these
investments are paid back to the investors in the proportion of
their capital contribution. (read
Top Three High Yield Financial ETFs
)
Investing directly in real estates involve large capital
commitments. However, mortgage REIT ETFs have been attracting
institutional as well as retail investors throughout the past
decade as a cost effective way to invest in real estate as an asset
class, which is known to generate solid returns over the long
term.
However, investing in mortgage finance ETFs have their own risks
which can impact prices of this sector going forward. This could be
especially true if the economy slowly begins to recover and if
interest rates continue to move higher.
Interest rate risk
results in fluctuations in the value of mortgage REIT investments
due to changes in benchmark rates. Since interest rates and prices
of mortgage securities are inversely related, the investments go
down in value if general interest rates increase and vice versa
when rates are slumping.
Credit risk
is the risk that arises when the mortgage borrower fails to honor
his payment obligation. When this situation arises, the market
values of the REITs are adversely impacted as non payment increases
the probability of insolvency and write-downs (read
Capital Markets ETFs For 2012?
).
Prepayment Risk
arises when the borrower pays the loan off before the in advance.
This generally happens in a decreasing interest rate scenario as
the borrower decides to pay off a loan in hopes of getting a new
one at a lower rate. This results in a notional loss for the
financing company thereby reducing the value of investments as it
ends of costing the company future coupon payments.
Leverage Risk
arises when the REITs borrow extra money from the market by keeping
their securities as collateral. This is done in order to earn a
higher amount of profits by capitalizing on the differences in
interest rates across shorter and longer ends of the yield curve.
On the contrary when interest rates go down, this magnifies the
losses for these companies (read
EUFN: The Best ETF For The Euro Crisis
).
Despite these risks, there are still several reasons why
mortgage finance firms could make for a compelling investment. Real
estate demand is finally starting to turn around and prices for
many REITs could surge as a result.
In fact, sales of existing homes in February marked the best
second month of the year for the industry since before the market
crash. Additionally, investors also saw the first year-over-year
price increase in home values since
November of 2010
.
If these trends continue, and if interest rates remain low, it
could give some REITs pricing power in many market segments. This
could be especially true in robust markets where there isn't very
much oversupply to begin with, a situation that could help to boost
the sector.
For investors looking to make a play on the broad space, there
are several options in the ETF world. These ETFs employ a basket
approach of investing across various mortgage finance firms,
ensuring that company specific risk is pretty much entirely
diversified away. As a result, any of the following three ETFs
could be great picks in this slowly recovering market:
Market Vectors Mortgage REIT ETF (
MORT
)
For investors looking at a high yielding equity income fund in
the mortgage finance space, MORT is an interesting option. The fund
tracks the price and yield performance of the 24 securities listed
in
Market Vectors Global Mortgage REITs Index
before fees and expenses.
The capitalization weighted index tracks the overall performance
of publicly traded mortgage REITs globally. MORT charges investors
net expenses of 40 basis points a year.
The fund holds 72% of its total assets in its top 10 holdings
and relies heavily on
Annaly Capital Management Inc, (
NLY
)
its top holding (18.66%). The ETF was launched by
Market Vectors
in August of 2011, and since then it has obtained a promising $
23.6 million in its asset base.
The fund pays out a solid yield of 10.84%. MORT gives very good
exposure throughout all levels of market capitalization, but
employs a core value style of investing as indicated by its low P/E
multiple of 7.33. To sum up, steady flow of income backed with
potential of long term capital appreciation is the backbone of this
particular fund.
iShares FTSE NAREIT Mortgage Plus Capped ETF (
REM
)
Launched in May of 2007 by iShares, REM is one of the oldest and
better performing ETFs in the mortgage finance space with over $278
million worth of total assets under management.
The passively managed ETF tries to replicate as closely as
possible the price and yield performance of the
FTSE NAREIT All Mortgage Capped Index.
The index measures the performance of the residential and
commercial mortgage real estate sector of the U.S equity
market.
The fund employs a value style of investing and holds a total of
28 securities in its portfolio, charging investors an average 48
basis points per annum in fees. The fund holds 73% of its net
assets in its top 10 holdings and pays out a whopping annual yield
of 11.13%
SPDR S&P Mortgage Finance ETF (
KME
)
This fund looks to resemble S&P Mortgage Finance Select
Industry Index before fees and expenses. The index is derived from
the mortgage financing, processing and marketing segment of the U.S
equity market. The components of the index have an average EPS
growth of 9.2%.
However, the fund does not lay much emphasis on current income
as indicated by its dividend yield at 2.93% per annum. Although the
fund holds only 45 securities in total, just 25.28% of its total
assets are in its top 10 holdings thereby offering investors a very
well diversified portfolio (read
Three ETFs With Incredible Diversification
).
The fund charges a paltry 35 basis points in fees and expenses
making it a low cost choice in this space, especially when compared
to its more real estate focused peers on this list.
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NLY
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