What are MBS and securitized assets?
Securitized assets are fixed-income securities backed by various cash flow producing assets. Issuers of securitized products pool these assets together and sell debt to investors that is collateralized by the pool of loans. Investors, in turn, are entitled to the principal and interest payments generated from those assets. MBS are a type of securitized asset and are backed by residential and commercial mortgages.
Agency MBS are probably the most well-known securitized asset and are issued by the three government-sponsored entities: Fannie Mae, Freddie Mac, and Ginnie Mae. This market is often viewed as having a similar risk profile to Treasuries because of the agencies’ ties to the U.S. government, although they typically offer slightly higher yields. While the MBS market is dominated by agency MBS, there is also a large and diverse market of nonagency residential and commercial MBS that carry varying degrees of credit risk and income.
In addition to providing exposure to the residential and commercial real estate markets, securitized assets can also be linked to the health of the U.S. consumer, primarily through the asset-backed securities market. This sector comprises securities backed by a range of assets or collateral, including credit card and auto receivables, student loans, time-share loans, container leases, and franchise royalties.
A huge but overlooked market
The U.S. market for securitized assets is very large at about $13 trillion,¹ and despite its size, is often underused by investors who focus on more traditional bond sectors.
Many bond investors hold Treasuries and investment-grade corporate debt as ballast in the core of their fixed-income portfolios. Those with higher risk tolerances may use an allocation to high-yield corporate and emerging-market bonds for added income. However, we believe the size of the securitized market should demand the attention of investors and may be deserving of a strategic allocation.
Major U.S. spread sectors (US$ billions)
Source: SIFMA, Barclays, J.P. Morgan, as of 6/30/21. IO/IIO are interest-only and inverse interest-only securities. CMO represents collateralized mortgage obligation.
Although the securitized market is large, it’s somewhat fragmented and consists of many smaller subsectors that have their own unique characteristics. Due to their perceived complexity, many of these securitized subsectors receive less attention from market participants and can be less efficient. We believe this creates opportunities for active managers with expertise to analyze these securities and identify undervalued assets.
Securitized assets and rising rates
One of the biggest sources of volatility within fixed-income markets comes from rising interest rates. While conventional fixed-income exposure may be negatively affected by higher rates, securitized assets are a tool that may help insulate portfolios and dampen volatility.
Most securitized assets are shorter duration, meaning they have less sensitivity to interest-rate movements. Many securities also carry floating-rate coupons as well as optionality through unique prepayment characteristics and deal structures that tend to outperform in periods of rising interest rates. Higher inflation expectations typically accompany a rising rate environment, and collateral tied to real estate markets can also help to shield securitized assets from inflationary pressure over the long term.
Why active for MBS and securitized assets
Within the MBS market, we believe an active strategy provides clear and differentiated advantages for investors. For example, although the mortgage-backed market is made up of a wide range of subsectors, no broad index exists that encompasses the market. As a result, most passive ETFs concentrate solely on the agency MBS market because of the availability of a replicable index.
An active approach lets investors access nonagency mortgages and a variety of securitized subsectors, which have different credit risks and often higher income than agency mortgages.
We believe it’s a mistake for investors to ignore MBS and other securitized assets that can provide income and diversification benefits. An actively managed ETF is one way to tap into this often-missed asset class.
1 SIFMA, Barclays, J.P. Morgan, as of 6/30/21.
The views presented are those of the author(s) and are subject to change. No forecasts are guaranteed. This commentary is provided for informational purposes only and is not an endorsement of any security, mutual fund, sector, or index. Past performance does not guarantee future results.
Fixed-income investments are subject to interest-rate and credit risk; their value will normally decline as interest rates rise or if an issuer is unable or unwilling to make principal or interest payments. Investments in higher-yielding, lower-rated securities include a higher risk of default. Foreign investing, especially in emerging markets, has additional risks, such as currency and market volatility and political and social instability. Mortgage- and asset-backed securities may be sensitive to changes in interest rates, and may be subject to early repayment and the market's perception of issuer creditworthiness.