Fixed income investors looking for bonds with credit profiles comparable to Treasuries with the potential for added upside into year-end and beyond may want to examine mortgage-backed securities (MBS).
That task is made easier with ETFs such as the WisdomTree Mortgage Plus Bond Fund (MTGP ). This ETF hit a 52-week high on Monday, extending its year-to-date gain to nearly 4%. That’s slightly better than what investors have earned with some of the largest passive aggregate bond ETFs. The Federal Reserve may cut interest rates this month. So MTGP could be all the more alluring to bond investors.
Following a disappointing August jobs report, the central bank likely has no choice but to trim borrowing costs. That’s material to the mortgage market and ETFs such as MTGP. That’s because if the Fed displays an unwillingness to lower interest rates, investor demand for agency mortgages — plenty of which reside in MTGP’s portfolio — would be dampened.
MTGP Ready to Shine
Assuming the Fed delivers expected rate reductions, the already-solid case for MTGP would be fortified. That is to say the ETF offers investors other compelling attributes, including value.
“And that relative value really does matter. Investors are looking for places to earn yield without taking on too much credit risk. Mortgages, particularly agency mortgages with government guarantee there, they offer that balance,” noted James Egan, co-head of securitized products research at Morgan Stanley.
One way to look at the importance of rate cuts as they pertain to MBS and ETFs like MTGP is that such moves by the Fed provide something important and something coveted by investors: clarity.
“With more clarity on Fed policy, banks in particular may get more comfortable adding mortgages to their balance [sheets. Although,] the exact timing depends on regulatory developments,” added Egan.
Another reason Fed action could be additive to the MTGP thesis is the elimination of volatility. Said another way, market participants attempting to game Fed moves can contribute to rate volatility. But when the central bank makes its intentions clear, that turbulence is often quelled. Should that scenario play out this month, it could be to the benefit of MTGP.
Significant Volatility Drop
“If you’re buying mortgages, you’re inherently short rate [volatility. And] volatility has come down meaningfully since last year, even if it’s still above pre-COVID norms. Lower volatility supported for mortgage valuations, especially when paired with a Fed that’s cutting rates steadily,” observed Egan.
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