The Case for Mortgage REITs in a Rising Rate Environment
The looming threat of rising interest rates doesn't have to be daunting when ETF investors embrace the phenomenon with funds like the Vanguard Mortgage-Backed Securities Index Fund ETF Shares (VMBS).
If a fixed income investor wants maximum yield on safe haven Treasury notes, they have to go as far out on the yield curve as possible. This means leveraging duration risk to the hilt.
Of course, there are alternatives. One is to seek alternate income sources like mortgage real estate investment trust (REITs).
"If you're looking for inflation-crushing income, give the mortgage REIT industry a good look," a Kiplinger's article said. "Unlike equity REITs, which are generally landlords with brick-and-mortar properties, mortgage REITs own leveraged portfolios of mortgages, mortgage-backed securities and other mortgage-related investments."
"In 'normal' economic times, mortgage REITs have a license to print money," the article added. "They borrow money at cheap, short-term rates, and invest the proceeds in higher-yielding longer-term securities. A steep yield curve in which longer-term rates are significantly higher than shorter-term rates is the ideal environment for mREITs, and that's precisely the scenario we have today."
VMBS seeks to track the performance of a market-weighted mortgage-backed securities index. The fund employs an indexing investment approach designed to track the performance of the Bloomberg Barclays U.S. MBS Float Adjusted Index., which covers U.S. agency mortgage-backed pass-through securities.
To be included in the index, pool aggregates must have at least $250 million currently outstanding and a weighted average maturity of at least 1 year. All of the fund's investments will be selected through the sampling process, and under normal circumstances, at least 80% of the fund's assets will be invested in bonds included in the index.
Overcoming REIT Concerns
Hesitant investors may be thinking about the financial crisis back in 2008. With certain mortgage REITs feeling the pangs of holding toxic assets like subprime mortgages, it may seem difficult to overcome the past.
Even as recently as last year, the potential of mortgage defaults was at a high due to the pandemic. With social distancing measures threatening jobs, many household incomes started to look risky.
However, the past also favors mortgage REITs.
"But here's the thing. Any mortgage REIT trading today is a survivor. They lived through the apocalypse. Whatever the future might hold, it's not likely to be as traumatic as a once-in-a-century pandemic," the Kiplinger's article concluded.
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