MBS ETFs: Rally Rolls on After Record-Setting Year

• Agency mortgage-backed securities (MBS) achieved their best year since 2002 by climbing over 8.5%.
• Demand for low-cost, indexed products has pushed total AUM past $6.5 billion for Schwab’s SMBS ETF since launching in 2024.
• Rising interest in active funds has driven more than $800 million in yearly inflows to PIMCO’s $1.3B PMBS ETF.

There’s an old Wall Street adage among bond traders: “A mortgage bond goes up like a two-year Treasury when rates fall, but crashes down like a 10-year Treasury when rates rise."

This structural negative convexity — or optionality — occurs because homeowners can refinance when rates fall. However, in today’s higher-for-longer rate environment, this embedded option is worth far less than in a typical cycle.

With the Federal Reserve caught in a “hawkish” holding pattern, the market expects neither aggressive hikes nor sharp cuts anytime soon. In fact, the futures market is pricing in fewer than two rate hikes through the end of 2027, while the Fed’s own dot plot points to fewer than two rate cuts.

This rangebound Treasury environment provides a protective sweet spot, allowing MBS to compound on high yields without the threat of dramatic duration changes. Despite narrowing spreads last year, agency MBS remain attractive compared to investment-grade corporate credit, especially amid an onslaught of debt issuance from AI hyperscalers. Investors are essentially getting paid for a government-guaranteed product with competitive yields.

Advisors looking for indexed products often rely on the likes of the iShares MBS ETF (MBB A), which remains the liquidity titan of the space at nearly $40 billion in total assets. Meanwhile, the Schwab Mortgage-Backed Securities ETF (SMBS ) has rapidly emerged as a low-cost, index-based heavyweight, ballooning to roughly $6.5 billion in assets since its late 2024 launch. Charging a net expense ratio of just 0.03%, the fund is currently among the cheapest on the market.

However, today’s market dynamics may favor active managers who can dynamically “cherry-pick” the mortgage stack. The underlying mortgage market is highly complex and nuanced, requiring dedicated teams to manage duration, execute complex bond swaps, and selectively rotate among mortgage pools.

PIMCO is among the largest, most prominent investors in MBS globally. ETFs like the PIMCO Mortgage-Backed Securities Active ETF (PMBS ) bypass the rigid weighting of standard benchmarks to tactically manage convexity and selectively rotate into non-agency and structured opportunities. This active approach offers a crucial “quality-first” alternative to the passive status quo.

“We continue to see good opportunities in the agency mortgage in 2026, with valuations on average looking cheap and differentiation of bonds within the market creating good relative value opportunities for active managers,” Dan Hyman, managing director and lead portfolio manager at PIMCO, said. He added that historically low supply, returning bank demand and the GSEs’ $200 billion balance sheet pledge combine to make the asset class an attractive high-quality investment opportunity.

The $1.3 billion ETF has seen more than $800 million in new money over the last 12 months, positioning it as an attractive vehicle for advisors who are looking for more alpha. The fund charges a net fee of 0.71%.

I will be sitting down with PIMCO’s Dan Hyman at VettaFi’s upcoming Midyear Market Outlook Symposium on June 25 to break down how his team is positioning for the second half of the year, how they are insulating portfolios against sudden shifts in volatility, and where the most attractive opportunities lie across the bond market.

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