Treasuries have been the default go-to safe haven bonds during times of heavy market volatility. But with Moody’s recent downgrade, an opportunity for mortgage-backed securities (MBS) exists.
Rising national debt caused Moody’s to bring down U.S. debt from the upper echelons of its credit rating tier. The short-term market response brought yields up while pushing Treasury prices down. As mentioned, the growing national debt continues to be a primary concern. That’s because the current presidential administration will need to balance spending while addressing the budgetary deficit.
“Successive U.S. administrations and Congress have failed to agree on measures to reverse the trend of large annual fiscal deficits and growing interest costs,” Moody’s explained. “We do not believe that material multi-year reductions in mandatory spending and deficits will result from current fiscal proposals under consideration.”
Included in the rising yields of Treasuries is the 10-year benchmark note. This affects the mortgage market because interest rates can use the 10-year note as a benchmark. For investors in MBS, the higher yield is a plus. That’s because, fundamentally, they aren’t directly tied to the U.S. credit rating.
An Alternate Source of Yield
MBS are an ideal option given the market uncertainty in both the stock and bond markets. For fixed income investors, this adds an alternate source of yield not directly tied to the bond markets like Treasuries or corporate debt. Thereby, that adds diversification.
“The stability provided by MBS is crucial for investors’ portfolios, as it offers a combination of diversification from corporate risk, low defaults and high recovery rates in the event of default,” explained Rankia Pro.
Given the compelling case of MBS, consider the Vanguard Mortgage-Backed Securities Index Fund ETF Shares (VMBS ). In addition to yield, VMBS focuses on high credit quality with its focus on MBS issued by government-owned corporations like Ginnie Mae and government-sponsored enterprises like Fannie Mae. These quasi-government entities help provide liquidity in the mortgage market by buying and selling mortgages in the secondary market.
Summarily, VMBS aims to:
- provide a moderate and sustainable level of current income.
- invest primarily in U.S. agency mortgage-backed pass-through securities issued by Ginnie Mae (GNMA), Fannie Mae (FNMA), and Freddie Mac (FHLMC). Having the backing of government agencies adds a higher degree of credit quality to these MBS issues.
- add diversification, with over 1,400 MBS holdings.
- provide a 30-day SEC yield of 4.12% as of May 16.
- lower costs with its 0.03% expense ratio.
For more news, information, and analysis, visit the Fixed Income Channel.
