More than a decade after the start of the financial crisis, mortgage-backed securities continue to be synonymous with scandal.
August began with Wells Fargo agreeing to pay a penalty in excess of $2 billion to settle allegations that residential mortgage-backed securities, including loans originated by the bank, contained misstated income information and did not meet the quality that Wells Fargo claimed. Their collapse during the financial crisis cost investors billions of dollars.
Then, at the end of August, Moody’s settled for more than $16 million over allegations that it had used faulty ratings models on hundreds of mortgage securities between 2010 and 2013, valued at a total of more than $25 billion.
Amid all this, mortgage-backed securities themselves haven’t done much to reward investors this year, with the Bloomberg Barclays US Mortgage Backed Securities index down by 1% through the first seven months of 2018.
However, some managers in the Bonds – Mortgages category have been generating alpha and may be expected to keep outperforming.
Largest by AUM
Within this portfolio, Citywire + rated Jeffrey Gundlach and AA-rated Philip Barach’s largest exposures are to non-agency residential mortgage-backed securities, agency collateralized mortgage obligations and agency pass-through securities.
Gundlach and Barach are betting that legacy non-agency mortgage-backed securities will outperform on a spread basis over the medium term, due to both technical and fundamental factors.
The duo also highlighted non-qualifying mortgages and non-performing loan securitization as attractive new issues, especially given their short durations and high relative yields.
Top by total return
AAA-rated David Goodson has not only delivered the highest total returns in this sector over the past three years; his Voya Securitized Credit fund has also beaten the index five times over. He has done this while keeping a low risk profile too, earning him an exceptional personal information ratio for the period of 3.43.
By sector, Goodson is positive on securitized assets, including asset-backed securities and non-agency residential mortgage-backed securities. His portfolio is underweight agency residential mortgage-backed securities on the basis that the unwinding of the Federal Reserve’s balance sheet skews the risks to the downside.
One to Watch
Run by + rated Tad Rivelle, Harrison Choi, Scott Austin and Mitchell Flack, the TCW Total Return Bond fund has surged up the performance table to 16th out of the 36 funds in this sector over the past year, having been in 33rd place over the previous 12 months.
The managers take a value-based approach, focusing on the higher quality and better collateralized parts of the market. For example, they consider non-agency mortgage-backed securities attractive, but felt that despite the appealing elements of agency mortgage-backed securities, they faced a significant headwind as the Federal Reserve reduces its holdings of such bonds.
Vanguard and iShares dominate the market for mortgage-backed securities ETFs. The iShares MBS ETF has $12.1 billion under management and a net expense ratio of 0.09%, while the Vanguard Mortgage-Backed Securities ETF has $7.7 billion and charges 0.07%. The larger size of the iShares product, though, means that it trades at a better spread.
The two ETFs also have different portfolio characteristics, with iShares tracking the Bloomberg Barclays US Mortgage Backed Securities index and Vanguard favoring the float-adjusted version of that index. The iShares fund owns more than 700 bonds, compared with just 574 for Vanguard, and has both a shorter duration and a higher average coupon.
*Data to July 31 2018 / Source: Citywire Discovery/Lipper