Profiting Off of Increased Mortgage Rates (PTRIX,FMSFX,VMBSX)
Rising mortgage rates can be bad news for prospective homebuyers, real estate agents, loan officers and others who profit when the demand for homes is high. Even though as of 2016, rates remain near all-time lows and would have to more than double just to return to historical averages, consumers are grumbling about the Fed rate hike passed in late 2015, and the effect it might have on mortgage rates moving forward. Industry analysts project 30-year fixed mortgage rates, which have hovered between 3.5 and 3.75% for several years, to cross the 4% barrier by year-end 2016 and then continue to edge upward. Real estate professionals are bracing for decreased demand amid higher borrowing costs.
While homebuyers and real estate agents prefer lower mortgage rates, investors can profit from rate increases by selecting the appropriate mutual funds. Funds that invest in mortgage-backed securities (MBS) derive their returns from the interest that homeowners and business owners pay on mortgage loans. An MBS is a fixed-income security backed by a pool of mortgage loans. Typically, when a mortgage lender closes a loan, rather than retaining ownership of that loan, the lender sells it on the secondary market to an investment bank or government-sponsored entity (GSE), which then packages it with a bunch of other loans and uses the resulting pool of loans to back a bond issue. Because they invest in MBS, the following mutual funds are positioned to offer strong returns if mortgage rates continue to rise.
PIMCO Mortgage-Backed Securities Fund (PTRIX)
Launched by PIMCO in 1997, the PIMCO Mortgage-Backed Securities Fund ("PTRIX") focuses on high-quality, intermediate-term bonds backed by MBS. An intermediate-term bond is one with a maturity date two to 10 years in the future. It carries less interest rate sensitivity than a short-term bond but more than a long-term bond. PTRIX is an index fund tracking the U.S. MBS Fixed Rate Index, which is composed of over 600,000 MBS pools. The fund's top holdings include Fannie Mae (OTC: FNMA) and Ginnie Mae bonds, at 4% and 3.5%, respectively. PTRIX carries an expense ratio of 0.5%. This is high for the intermediate-term bond category, which averages 0.24%.
Fidelity Mortgage Securities Fund (FMSFX)
Compared to PIMCO's fund, the Fidelity Mortgage Securities Fund ("FMSFX") invests in a broader range of credit qualities, though it still keeps the lion's share of its assets, at least 80%, in high-quality bonds backed by MBS. As an index fund launched in 1984, it tracks the Barclay's Mortgage-Backed Securities Index, which represents pools of mortgages issued by Fannie Mae, Freddie Mac (OTC: FMCC) and Ginnie Mae. The fund's top holdings include Fannie Mae bonds at 3 to 4%, Ginnie Mae bonds at 3.5% and Freddie Mac bonds at 3.5%. The fund's expense ratio is 0.45%.
Vanguard Mortgage-Backed Securities Index Fund (VMBSX)
Launched in December 2009, the Vanguard Mortgage-Backed Securities Index Fund Admiral Shares ("VMBSX") represents the newest fund on the list. It focuses on high-quality, intermediate-term bonds backed by MBS. Its benchmark index is the Barclay's Mortgage-Backed Securities Float-Adjusted Index. VMBSX's top holdings include MBS issued by Ginnie Mae, Freddie Mac and Fannie Mae. Like with most Vanguard funds, the expense ratio for VMBSX is well below average at 0.1%.