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For advisors and investors with long memories, considering mortgage-backed securities (MBS) might sound like heresy because those bonds were among the most infamous during the global financial crisis.
Granted, that was a long time ago, but the Federal Reserve is still sitting on hundreds of billions in losses on the $2.3 trillion in MBS it bought to prop up of the housing market during the crisis. By some estimates, those losses are roughly 10 times the interest the central bank collects on those bonds.
Today, MBS remains a vital and large corner of the bond market and, more importantly, those bonds are on much sturdier ground today than they were 2007 through 2009. That durability highlights investment opportunity with MBS, which is made easier via exchange traded funds. Add the Schwab Mortgage-Backed Securities ETF (NYSE Arca: SMBS) to that group.
SMBS is expected to debut next week and that could signal the ETF could be well-timed, particularly if the Fed continues paring interest rates.
“If the Fed decides to become aggressive and cut rates faster than expected, it could trigger what’s known as a ‘refi wave,’” noted David Varano, director of business development at ICE. “That’s when people pre-pay their mortgages en masse during a relatively short period. All that pre-payment activity during a relatively short amount of time can create disruption. In the capital markets, new issuance rises as older bonds are retired either partially or in [full. That would leave] investors flush with principal that needs to seek reinvestment opportunities.”
SMBS Straight-Forward Income Approach
SMBS, which will track the Bloomberg US MBS Float Adjusted Total Return Index, could be an ideal consideration for advisors looking to generate income for clients that are risk-averse. The reason being is that MBS typically sport higher yields than Treasury with comparable credit profiles. After all, MBS are backed by government-sponsored entities (GSE).
“It’s not an apples-to-apples comparison, but despite the underlying mortgages generally starting with 30-year maturities, it usually doesn’t take all 30 years to get the investment back, since most monthly payments include both principal and interest,” noted Collin Martin of Charles Schwab. “Over the last 15 years, the Bloomberg US Mortgage-Backed Securities Index offered an average yield advantage of just 55 basis points (or 0.55%) over the 10-year Treasury [yield. So] that 80-basis-point advantage appears attractive now.”
SMBS is the 11th fixed income ETF in the Schwab stable and comes to market as the firm nears its 15th anniversary in the ETF arena.
“This launch is a prime example of how we are leveraging our scale and deep capital markets expertise to bring investors and advisors competitively priced offerings that provide core market exposures for well-diversified portfolios,” said Nicohl Bogan, Head of Passive Product Management & Innovation, Schwab Asset Management, in a statement.
SMBS Keeps with Schwab ETF Tradition
Beyond its enviable brand recognition and strong presence in the advisory community, one of the reasons Schwab is now the fifth-largest ETF issuer despite a late entry into the space is because it competes and wins and fees.
The new SMBS keeps with that tradition and will be one of the most cost-effective choices in the MBS ETF category.
“With an expense ratio of 0.03%, the Schwab Mortgage-Backed Securities ETF is priced in line with the lowest-priced peer ETFs based on the U.S. Mortgage Lipper category,” according to the press release.
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