An MBS is developed by restructuring a collection of illiquid loans into a single tradeable security. The securities are rated by the quality of the credit attached to the underlying pool of loans. Coupons are assigned based on the loan ratings, with lower-rated securities having higher coupons to attract investors successfully. Typically, MBS are guaranteed by government-sponsored enterprises, including Ginnie Mae, Fannie Mae and Freddie Mac. They are referred to as pass-through securities because an intermediary passes through payments from the issuer to the security holders.
The demand for real estate has made a convincing turnaround since the 2008 financial crisis, with February 2015 being the second most profitable month for home sales since 2008 and showing the first year-over-year price increase since November 2010. As interest rates remain low, there will likely be substantial increases in demand for mortgage loans, resulting in the establishment of more asset-based securities, potentially increasing the pool of high-quality assets in this investment category.
The iShares Barclays MBS Bond ETF
The iShares Barclays MBS Bond ETF (NYSE Arca: MBB) is a good option for investors looking to invest in fixed-rate mortgage pass-through securities issued by the Federal National Mortgage Association (FNMA), the Government National Mortgage Association (GNMA) or the Federal Home Loan Mortgage Corporation (FHLMC). The fund aims to provide investors with results that track the performance of the Barclays U.S. MBS Index. The pass-through securities comprising the underlying index have 30-, 20- and 15-year maturities. Along with fixed-rate mortgages, the index also includes hybrid-type adjustable rate mortgages.
MBB has total assets of $7.3 billion. The 2015 five-year return is approximately 12.7%. The fund is medium-risk. Its expense ratio is 0.27%, and it has a 1.75% dividend yield. The fund's holdings have an average yield to maturity of 2.22% and a weighted average maturity of 4.7 years.
The SPDR Barclays Capital Mortgage Backed Bond ETF
The SPDR Barclays Capital Mortgage Backed Bond ETF (NYSE Arca: MBG) is a good fit for investors seeking above-average yields in return for accepting a slightly higher (still relatively moderate) level of risk. The dividend yield for this fund is 3.88%, almost twice the yield of MBB.
MBG attempts to provide investors with investment results that mirror the performance of the Barclays U.S. MBS Index, excluding fees. The index is a benchmark metric for the performance of investment-grade U.S. agency mortgage pass-through securities. The securities are backed by pools of mortgages and are issued by government-sponsored entities such as FHLMC, GNMA and FNMA.
This State Street fund has an asset base of approximately $1.5 million, and trades about 29,000 shares daily. The expense ratio is 0.2%. The fund's five-year return, as of 2015, is 13.91%. Average yield to maturity for fund holdings is 2.23% and the fund has an average maturity of approximately 4.7 years.
The Vanguard Mortgage Backed Securities ETF
The Vanguard Mortgage Backed Securities Index ETF (Nasdaq: VMBS) seeks to follow the performance of the Barclays Capital U.S. MBS Float Adjusted Index. The index includes U.S. agency mortgage backed pass-through securities issued by entities such as the FNMA. To be eligible for inclusion in the index, aggregates must have a minimum of $250 million outstanding and a weighted average maturity of at least one year.
This Vanguard-issued fund has an asset base totaling $1.5 billion. It's considered to have a moderate risk level. The expense ratio is extremely low, only 0.12%. The fund offers a 1.31% dividend yield. The average yield to maturity is 2.15%, and the average maturity is 4.5 years. Besides its notably low fees, this fund's appeal is that it is the only one with solidly AAA-rated holdings.