With their attractive yields in the current market environment, bond funds of various varieties have been seeing increased demand. But to diversify a fixed income portfolio, investors may want to add mortgage-backed securities (MBS).
Once the central bank decides to loosen monetary policy, yields will eventually decline, thereby making MBS an alternate route to attain yield. When bond markets get volatile, the diversification that MBS offer can also be beneficial.
“Investors seeking greater portfolio diversification, as well as the prospect of higher returns in a treasury-like market, should consider mortgage-backed securities (MBS),” noted Vikas Jain, co-head of fixed income and systematic research at Bloomberg Indices.
Getting access to MBS used to be a difficult market to penetrate for the retail investor looking to attain yield from mortgages. But the advent of the ETF changed the proverbial game. That said, an easy path to exposure would be the Vanguard Mortgage-Backed Securities Index Fund ETF Shares (VMBS).
“MBS market access can be a challenge, as the management of MBS pools is operationally complex for some investors due to monthly principal payments, not to mention the challenges of sourcing specified pools,” Jain added. “Agency MBS ETFs offer an alternative option for accessing MBS markets, as they generally offer better liquidity than the specified pools and are usually simpler to manage for investors.”
Backed by Government-Sponsored Enterprises
The fund offers a low expense ratio of 0.04%. To help minimize credit risk, VMBS holdings focus on MBS issued by government-owned corporations like Ginnie Mae and government-sponsored enterprises like Fannie Mae. Both of these quasi-government entities help to provide liquidity in the mortgage market by buying and selling mortgages in the secondary market, so their role is essential. Thus, this backing adds to the relative quality of these assets.
“Agency MBS are unique in that they are either explicitly or implicitly guaranteed by government-sponsored enterprises (GSEs) like Fannie Mae and Freddie Mac, thus providing investors a shield from homeowners’ default risk, while also providing historically higher yields than Treasury bonds with similar duration,” continued Jain
Salient features of VMBS:
- Seeks to provide a moderate and sustainable level of current income.
- Invests primarily in U.S. agency mortgage-backed pass-through securities issued by Ginnie Mae (GNMA), Fannie Mae (FNMA), and Freddie Mac (FHLMC).
- Moderate interest rate risk, with a dollar-weighted average maturity of three to 10 years.
- 30-day SEC yield of 3.91% as of March 1
For more news, information, and strategy, visit the Fixed Income Channel.