Get A Mortgage To Pay You With This ETF

Investors who remember the role various real estate-related securities played in global financial crisis may be skittish about embracing an exchanged-traded fund dedicated to mortgage-backed securities, but some funds dedicated to this asset class are relatively low risk and offer investors an avenue for generating yields that are better than cash investments.

Ginnie, Freddie And Fannie

MBS, also known as “mortgage pass throughs,” are accessible via the Vanguard Mortgage-Backed Securities ETF VMBS. VMBS is a cost-efficient avenue to the MBS market and this ETF invests mostly in U.S. agency mortgage-backed pass-through securities issued by Government National Mortgage Association "Ginnie Mae," Federal National Mortgage Association FNMA and Federal Home Loan Mortgage Corp FMCC.

VMBS's Holdings, Explored

VMBS holds 552 issues, over 96 percent of which yield between 3–5 years and 5–10 years. The ETF has a 30-day SEC yield of around 1.8 percent, which is below the yield on 10-year Treasuries, but well above what investors will earn with money markets and other cash investments.

“Since the fund's November 2009 inception, its index-tracking record has been solid,” said Morningstar in a recent note. “From November 2009 through March 2017, the fund trailed its index by 0.04 percent on an annualized basis, net of its 0.07 percent fee. Its three- and five-year annualized returns of 2.5 percent and 1.9 percent were on par with its index peers. However, the fund's return lagged the average actively managed mortgage fund by 19 basis points and 14 basis points over the trailing three- and five-year periods, respectively.”

Looking Beyond The '08-'09 Crisis

Given that VMBS debuted in late 2009, investors can only guess how the ETF would have performed if it had been around for the darkest days of the financial crisis. What is clear is that MBS would beloved by banks because the securities allowed them to move mortgages off their books by selling MBS to investors, thereby positioning the banks to lend more money. The system worked for a while until banks loaned too much money to subprime borrowers and when those borrowers started defaulting, the housing market suffered.

The Federal Reserve absorbed some toxic MBS, but has said it plans to unload some of those securities this year. Still, VMBS is up more than 1 percent year-to-date. The ETF has returned 6.7 percent over the past three years with minimal volatility, but that performance is well behind those offered by medium-term and long-dated Treasury ETFs, which are more sensitive to interest rate changes.

“As of March 2017, Fannie Mae and Freddie Mac securities took up approximately 70 percent of the fund. These securities offer slightly higher coupons than Ginnie Mae bonds to compensate for default risk as they are not explicitly guaranteed by the U.S. government,” said Morningstar.

VMBS charges just 0.07 percent per year, making it cheaper than 92 percent of competing strategies, according to issuer data.