4 Reasons to Invest in Mortgage-Backed Securities
Mortgage-backed securities (MBS) can play an important role as a fixed income asset class that offers several benefits. In addition to historically attractive yields compared with Treasuries and low volatility, these highly liquid assets provide diversification, which can lower portfolio risk.
Many fixed income investment managers, including Diamond Hill, make significant allocations to agency and non-agency MBS for the variety of benefits they offer.
1. Historically attractive yields relative to Treasuries.
Agency MBS may improve the risk-return profile of fixed income portfolios, as they are similar in credit quality to Treasuries but with a higher historical yield. Over the last 10 years, MBS yields have averaged 2.53% over Treasury bills (see Figure 1 below).
FIGURE 1: COMPARATIVE YIELDS: MORTGAGE-BACKED SECURITIES VS. TREASURIES
Source: Bloomberg Barclays Live.
2. Generally high risk-adjusted returns.
MBS have historically experienced low volatility compared to other fixed income asset classes, while the Sharpe ratio has been historically high compared to most other fixed income asset classes (see Figure 2 below).
FIGURE 2: 10-YEAR STANDARD DEVIATION & SHARPE RATIO
Source: Morningstar Direct. As of 3/31/19.
3. Diversification due to low correlation to other asset classes.
Since their returns move inversely to other fixed income asset classes, MBS may also serve to lower the risk of portfolios. For most fixed income securities, as interest rates rise, prices decline, and as interest rates fall, prices increase. However, borrowers’ prepayments, and changes in the level and speed of repayment, can affect MBS valuation. The prices of agency MBS tend to rise as interest rates rise, when prepayment levels are low, and decline when interest rates drop and prepayments are higher. Agency MBS also have a lower correlation to equity returns than most other fixed income asset classes.
4. The liquidity of the market.
The agency MBS market is large and highly liquid, with $7.3 trillion in assets outstanding and an average daily trading volume of $270 billion (Source: Securities Industry and Financial Markets Association. As of March 31, 2019). This liquidity makes it relatively easy for buyers to find sellers and vice versa, and transaction costs tend to be lower.
Learn More about Diamond Hill Fixed Income
Through a rigorous research-based bottom-up approach, Diamond Hill delivers unique fixed income solutions to clients, providing diversification while managing downside risk.
For more information, call 855.255.8955.