In the search for income, investors may want to take a look at mortgage-backed securities. MBS are debt obligations with cash flows tied to the principal and interest payment on a pool of mortgages. The AAA asset class in agency MBS can bring in a yield ranging as high as 5.5% to 6%, said Leslie Falconio, head of fixed income strategy in UBS Americas’ chief investment office. “Their time has come,” she wrote in a July 13 note. Even bond king Jeffrey Gundlach is a fan of mortgaged-backed securities, saying on a June investor call that “this may be one of the most attractive entry points to own the agency mortgage market.” “Mortgage spreads are still really attractive, particularly related to their lack of negative convexity ,” Gundlach said, referrring to a measure of the relationship between bond prices and bond yields. “Agency mortgages are the cheapest part, on a risk adjusted basis certainly, in the entire fixed income market.” Mortgage-backed securities underperformed in 2022 and the first part of this year thanks to interest rate volatility, but that volatility should start to move down as the Federal Reserve wraps up its rate hikes, Falconio explained. She specifically likes agency MBS and expects them to “materially outperform” in the second half of the year. “The yield that you can earn for, say, a current coupon and the spread you’re earning is almost similar to something in a BBB [investment grade] corporate [bond], yet you have the AAA rating, you have the liquidity, and during the second half of the year, and in the first quarter of ’24, when growth begins to slow, we think that this will be a very good opportunistic relative value play across industries,” Falconio told CNBC. Her bias is towards a higher coupon. Luis Alvarado, a fixed income strategist at Wells Fargo, also looks at MBS as a possible replacement for some investment grade corporate debt in a fixed-income portfolio. He’s currently neutral on the asset class but said the bias is starting to turn a bit more positive. The macroeconomic environment is going to dictate a lot, but there are pockets of value being created, Alvarado said. “Spreads on mortgages widened pretty significantly — volatility was high, of course, so it’s difficult to time it — but that presents opportunities in our tactical framework,” he said, noting that framework is usually between six to 18 months. Money managers and financial advisors will be looking to take advantage of 4% to 6% coupons, but regular investors will probably find it easier to turn to a mutual fund or exchange-traded fund, Alvarado said. Here are some MBS ETFs. For those turning to a fund, Alvarado recommends finding one that is actively managed. “If interest rate volatility were to pick up for whatever reason … it would be better off for the money manager to be able to play it according to the volatility, because we might be a little bit too early,” he said. However, he does not favor commercial mortgage-backed securities. Wells Fargo recently downgraded CMBS to unfavorable from neutral, saying it believes commercial real estate values “will likely continue to deteriorate.” UBS’ Falconio is also awaiting a better entry point for CMBS, as well as non-agency MBS. Slower growth into the second half may cause some spread volatility, she wrote in her note. — CNBC’s Michael Bloom contributed reporting.
