I know what you are thinking, mortgage-backed securities, aren’t those what caused the financial crisis in 2008? The answer, in a nutshell, is, well yes! But, despite these products causing all that destruction just a decade ago, they have never really disappeared. Some investors have been using ever since and will likely continue using them in the future.
But, just because your neighbor jumps off a bridge, doesn’t mean you should follow along.
Besides just ‘blindly’ following your neighbor, there are a number of reasons why these MBS ETFs can look appealing. The first and foremost is certainly their high yield. The iShares MBS ETF (MBB) currently offers a yield of 3.73%, while the Vanguard Mortgage-Backed Securities ETF (VMBS) is offering a yield of 3.47% and the First Trust Low Duration Opportunities ETF (LMBS) currently yields 3.5%.
Another is the fact that some of the MBS ETFs boast the idea that the mortgage’s they own are backed by Fannie Mae, Freddie Mac or Ginnie Mae, which are essentially offering insurance to MBS investors on the chance that a large number of mortgagors begin to default.
MBS ETFs offer a great yield and insurance to protect your investment, what is not to like?
While the insurance is reassuring to some, the fact of the matter is these companies are not “backed” by the Federal Government and at the end of the day could themselves collapse if the housing market got terrible. During the last financial crisis, the Federal Government did step in and help these companies, but that doesn’t mean they will do it again. Furthermore, if only one of the three companies gets in trouble, its unlikely anything will be done since that may not affect the entire mortgage industry.
This also leads to the idea that while these companies do offer investors “insurance” on the MBSs, that doesn’t mean all of the mortgages bundled into the MBS will be protected. The insurance typically just covers a catastrophic collapse when a large number of mortgages see defaults. This means that while your “whole” investment may be protected, not all of it will be safe. At the end of the day, we need to remember that when it comes to investing, there are absolutely no guarantees. What may sound safe from a surface level may not be that conservative when digging a little deeper.
The other issue with MBS ETFs is that they will face the same interest rate risk as any other bond investment. The MBSs are made up of older mortgages which will have lower interest rates attached to them than what is being sold today. This means that the MBS you buy today may have a bunch of mortgages with 4.5% interest rates, but in a few months from now, we could see mortgage rates at 5% or a 5.5%. The 4.5% interest rate mortgage will not be worth as much as the 5% mortgage, which will cause the value of the MBS to fall.
Another issue with rising mortgage rates is that we could see an increased number of mortgage defaults if the MBS holds a high percentage of adjustable rate mortgages and those rates increase to levels that the mortgagee can’t afford to pay, (i.e., the financial crisis all over again).
Finally, while the yields and supposed safety of MBS ETFs could be attractive, the fast of the matter is over the past year, these products have not performed well. MBB, the largest MBS ETF by assets under management of $11.77 billion, is actually down 1.65% over the last 12 months, and 1.74% year-to-date. VMBS, the second largest by assets under management at $7.14 billion, is off by 1.52% over the last 12 months and year-to-date. Once you back out the loss these ETFs have taken, the yields don’t really matter because your investment is now only up around 2%.
My issue with MBS ETFs and other investment products is not necessary that they are bad investments, but that they offer a false sense of safety and security to naïve investors when in reality they actually may be riskier than traditional “growth” investments. Do your research before ever buying an investment that on the surface may seem like the “next” great thing.
Matt Thalman
INO.com Contributor - ETFs
Follow me on Twitter @mthalman5513
Disclosure: This contributor held positions in Facebook, Apple, Amazon.com, Netflix, and Alphabet at the time this blog post was published. This article is the opinion of the contributor themselves. The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. This contributor is not receiving compensation (other than from INO.com) for their opinion.
