For investors seeking exposure to income generated through investment-grade mortgage pass-through securities, the iShares MBS ETF (NYSEARCA: MBB) offers a pure play on the category, with a portfolio composed of pass-through debt instruments issued by U.S agencies. The portfolio holds both fixed- and floating-rate mortgage-backed securities (MBS) issued by the Government National Mortgage Association (NYSEARCA: GNMA), the Federal National Mortgage Association (OTC: FNMA) and the Federal Home Loan Mortgage Association (OTC: FMCC).

Fund Metrics

With an inception date of March 13, 2007, the iShares MBS ETF is the oldest exchange-traded fund (ETF) in the category. It is also the largest, with $8.27 billion in assets under management (AUM), as of May 11, 2016. Based on the trailing 45 trading days, the fund averages $59.39 million in volume per day.

The liquidity provided by steady trading volume results in a narrow average trading spread of 0.03%, which facilitates timely and efficient executions for institutional traders. The expense ratio of the iShares MBS ETF is 0.27%, about average for the category. The fund pays a distribution yield of 2.66%.

Portfolio Holdings

The portfolio of the iShares MBS ETF tracks the Barclays U.S. MBS Index with a market-weighted portfolio of investment-grade mortgage pass-through securities. As of May 11, 2016, the fund carried 892 positions, with the highest allocation in the portfolio going to debt issued by FNMA at 47.38%, followed by 25.81% with FHLMC and 24.49% to GNMA.

While the fund can hold floating-rate debt, it is heavily weighted toward fixed-rate instruments, which represent 97.57% of the portfolio. The average maturity of debt in the portfolio is 26.03 years, with duration at 4.9 years. The low duration reduces interest rate sensitivity as well as volatility, as indicated by the fund's beta of 0.78% versus its standard index.

Fund Management

The iShares series of ETFs are issued by BlackRock Inc. (NYSE: BLK), one of the largest money management firms in the world, with $4.6 trillion in AUM, as of Dec. 31, 2016. The firm has issued 336 iShares ETFs that cover a range of asset classes, including bonds, equities and commodities.

The iShares MBS ETF has managed to track the returns of its benchmark index while maximizing yield and minimizing volatility. The fund's negligible volatility is evidenced by its trading range over the 52-week period ending May 11, 2016, which had a variance from high to low of 2.3%.

Performance

Since its inception, the iShares MBS ETF has benefited from historically low interest rates implemented by the Federal Reserve Bank after the 2007-2008 financial crisis. The fund's best year occurred as the crisis deepened in 2008 and investors fled subprime mortgages for the safety of agency-issued mortgages. For the year, the fund returned 7.93%. From 2008 through 2011, the fund had an average yearly gain of 6.01%.

As investors incorporated more risk in their fixed-income portfolios starting in 2012, the returns of the iShares MBS ETF slowed. In 2013, the fund recorded its only yearly loss since inception, with a return of negative 1.95%. The average yearly return from 2012 through 2015 was 1.88%.

Added Value

The iShares MBS ETF can add value under several circumstances. For risk-averse investors, the portfolio of agency-issued debt virtually eliminates credit risk, pays a higher distribution yield than Treasury-based ETFs and displays a minimal level of volatility.

At times of high volatility in the markets, equity investors may find that rotating a portion of their portfolios to the fund can reduce overall volatility. The fund's tight yearly trading range also makes it suitable as a higher-paying proxy for money market funds, but investors should be aware that the higher yield of the fund is accompanied by higher risk.

Key Takeaways

The iShares MBS ETF offers investors a portfolio of agency-issued debt paying a higher dividend yield than comparable Treasury debt. The fund’s low volatility, as exhibited by its narrow yearly trading ranges and low beta, make it a suitable portfolio addition for risk-averse fixed-income investors.

The fund’s primary competitors are the Vanguard Mortgage-Backed Securities ETF (NASDAQ: VMBS) and the SPDR Barclays Mortgage Backed Bond ETF (NYSEARCA: MBG). The iShares MBS ETF compares favorably against both, particularly in terms of liquidity and distribution yield.

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