2023-12-28 16:36:35 ET
Summary
- The Fed's pivot has positively impacted stocks and led to a surge in the mortgage-backed security space.
- iShares MBS ETF offers low credit risk and exposure to fixed-rate, investment-grade MBS issued or guaranteed by U.S. government agencies.
- MBB's portfolio includes top issuers such as Fannie Mae, Freddie Mac, Ginnie Mae, and Uniform MBS, providing diversification in the mortgage market.
The Fed's pivot has been a significant positive to stocks, but one area not talked about which really surged is the mortgage-backed security, or MBS, space. I think this is an interesting part of the market that's worth focusing on through the iShares MBS ETF ( MBB ).
In its essence, MBB is a longer-duration play with very low credit risk, making it an intriguing prospect for investors seeking exposure to mortgage-backed securities. It primarily invests in fixed-rate, investment-grade MBS issued or guaranteed by U.S. government agencies. It has an expense ratio of just 0.04%, making it a cost-effective investment vehicle for those interested in allocating here.
A Deep Dive into Issuers
MBB's portfolio comprises a vast array of mortgage-backed securities. Top issuers include:
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Federal National Mortgage Association (FNMA): Often known as Fannie Mae, this government-sponsored enterprise is a key player in the U.S. secondary mortgage market. It purchases and guarantees mortgages from lenders, thereby ensuring liquidity in the market. It constitutes the lion's share of MBB's holdings.
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Federal Home Loan Mortgage Corporation (FHLMC): Commonly referred to as Freddie Mac, this entity is another pillar of the U.S. mortgage market. Similar to Fannie Mae, it buys mortgages, packages them into MBS, and sells them to investors, playing a pivotal role in maintaining liquidity.
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Government National Mortgage Association II (GNMA II): Unlike Fannie Mae and Freddie Mac, Ginnie Mae is a wholly-owned government corporation. It guarantees the timely payment of principal and interest on federally insured loans, such as those of the Federal Housing Administration and the Department of Veterans Affairs.
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Uniform MBS: This is a new class of MBS introduced by the Federal Housing Finance Agency to align Fannie Mae and Freddie Mac's cash flows. It aims to reduce the differences between individual MBS and promote liquidity.
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Federal Home Loan Mortgage Corporation - Gold: These are specific MBS issued by Freddie Mac, characterized by their solid credit quality and high liquidity.
Evaluating the Sector Composition and Weightings
MBB's portfolio is well-diversified across various sectors of the mortgage market, although it has a heavy concentration in U.S. government-backed MBS. This is largely due to the inherent safety these instruments provide, given their backing by federal entities. Furthermore, MBB's exposure is predominantly to intermediate fixed-rate securities, with a significant chunk allocated to 7 to 10-year securities. This ensures a stable and predictable income stream for the ETF (current effective duration is 5.72 years).
Peer Comparison: MBB vs. the Competition
Other notable ETFs in the MBS space include the Vanguard Mortgage-Backed Securities ETF (VMBS) and the FlexShares Disciplined Duration MBS Index Fund ETF ( MBSD ). While these ETFs have similar investment objectives as MBB, they differ in terms of expense ratios, holdings, and performance metrics.
Weighing the Pros and Cons
Investing in MBB comes with its unique set of advantages and potential pitfalls. On the upside, MBB offers broad exposure to the U.S. MBS market at a low cost. It provides a steady income stream, thanks to its focus on fixed-rate, investment-grade MBS. It also carries a lower risk profile due to the government backing of its assets.
However, the MBB isn't without its drawbacks. Its susceptibility to interest rate fluctuations could impact its performance. Furthermore, the phenomenon of negative convexity, inherent in MBS, could limit the upside potential of MBB during periods of falling interest rates.
The Verdict: To Invest or Not to Invest?
The iShares MBS ETF offers a unique opportunity to gain exposure to the U.S. mortgage market with low credit risk. However, its sensitivity to interest rate movements and the impact of negative convexity warrant careful consideration. It's a good fund for a part of the marketplace that doesn't get as much attention in the mainstream media, and is worth considering for conservative investors.
For further details see:
MBB: A Good ETF To Access Mortgage-Backed Securities