Hacked off with soaring housing costs and stubborn mortgage rates? Disgusted by skimpy supply and the fierce bidding wars that are now required to find a decent place to live?
If you’re looking for revenge, buy mortgage-backed securities.
No, investing in these lesser-known financial instruments won’t directly cut high housing costs. But it will position you to gain from a housing opportunity that has remained hidden by bond pundits’ persistent fixation on the Federal Reserve.
I write mostly on stocks, but a bargain is a bargain. If you’re taking retirement cash flow or just crave lower volatility, blending bonds with stocks can help.
And, yes, you could buy Treasurys – longer-term maturities if rates are falling, shorter-term if you think rates will rise. Or corporate bonds for higher yields and ties to economic growth. Or high-yield corporates (aka “junk” bonds) for occasional stock-like returns.
But to really impress friends and family, explore mortgage-backed securities. MBSs suffer a bum rap from low-quality versions that played a starring role in 2008’s financial crisis. But this isn’t that. Rather, meet MBSs backed by Fannie Mae and Freddie Mac. After the 2008-era rescue, these bonds have US government backing. Treasury-like quality! So, where is the opportunity?
Usually, agency MBSs act like Treasurys’ sad cousins. As Treasury bond prices rise, similar maturity agency MBSs’ prices usually rise less. When Treasurys fall, MBSs usually fall more (in trading jargon, that’s called “negative convexity” – Google it for giggles).
Why? Because historically, people moved or refinanced, repaying their loans early.
Not now. Everything that frustrates you with today’s housing creates an agency-backed MBS sweet spot. Those aggravating 7% mortgage rates mean hardly anyone refinances. Why would they? Most homeowners enjoy older rates far below today’s. This is great for MBSs: It means less refinancing push and pull on MBSs yields.
Bond prices and yields move inversely. When long rates fall, existing, higher-rate bonds look more attractive, so their prices rise more. While Fed cut talk now abounds, those are about short-term rates. The free market sets long rates. Markets pre-price all widely discussed topics. Long-term Treasury yields shouldn’t fall much from Fed cuts because they’re already expected.
Mortgage rates are historically quite high relative to Treasury yields. That won’t last. Mortgage rates’ happy place is closer to 20- or 30-year Treasury yields. But simple volatility pushed them higher lately. As that reverses and long rates fall somewhat – and bond prices rise – agency MBS prices should rise even more, boosting your total returns.
How to implement this? Simple: ETFs.
VMBS and SPMB are two of several tickers fitting the agency MBS bill well. You can trade these in a flash with minimal (or no) cost.
Tempted to do it yourself via individual bonds? Don’t. Bond markups and embedded trading costs can be astronomical for retail investors. Individual MBSs aren’t easy to buy and sell in small doses. Liquidity can worsen as they age and more of the underlying mortgages’ principal is repaid. You could end up with positions too small to sell.
Properly managing agency MBSs directly requires frequent rebalancing to reinvest the returned principal. More trading costs and bad pricing! Brokers would eat too much of your returns.
The ETFs solve all that, buying and selling like institutions do, providing you access to better pricing and far lower trading costs. Check prospectuses, naturally. But these generally keep fees super low – more return for you. They also keep you diversified and with a range of maturities. You won’t be overexposed to long or short durations (which would concentrate risks and overlook opportunities). You’ll get balance.
So, yes – high mortgage rates frustrate would-be homeowners. But the angst hides opportunity for you.
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