Generate More Income And Maintain Safety With Mortgage-Backed Securities – Seeking Alpha

February 6, 2022 By admin

IvelinRadkov/iStock via Getty Images

Don’t hold cash or CDs. A separately managed account (SMA) of high-quality short-term mortgage-backed securities (MBS) can generate dramatically more income, while keeping a high level of safety and liquidity.
Bond mutual funds or ETFs can be a good alternative to money market accounts. Unfortunately, they often take much more risk by holding weaker credit ratings and longer maturities.
It’s crucial that the separately managed account be managed by someone who specializes in MBS. In addition, an MBS expert at a smaller shop can often be much more opportunistic and capture more alpha.
Under the right manager, an SMA of high-quality short-term MBS has the potential to generate substantially more income than a money market account, CDs, or many short-term bond funds. As a bonus, an MBS separate account may have far lower risk and volatility than an ETF or mutual fund takes to earn a similar return. Thus, the MBS separate account may be a much better cash alternative.
Don’t hold cash or CDs. You can earn way more income on super safe mortgage-backed securities.
Many investors keep a portion of their portfolio in money market accounts, bank deposits or CDs. Sure, that makes sense for near-term liquidity needs. But, if you don’t need immediate liquidity, why hold assets that earn close to zero? An SMA using short average maturity MBS, may target a 1.50% to 2.00% return. If you can allow your SMA manager a little time to raise cash when you need liquidity, you can earn way more income and maintain a high level of safety and liquidity. Think about that for a moment … this trade may really be a layup. A no-brainer. I know. It is something we have been doing for our clients for years.
The MBS we’re suggesting are issued and guaranteed by Fannie Mae, Freddie Mac, or Ginnie Mae – all government sponsored entities. I believe this guarantee greatly diminishes or even eliminates credit risk. These MBS tend to perform well in the most difficult markets, like they did during the Covid crisis of early 2020.
An SMA of these extremely high-quality mortgage-backed securities, with a relatively short average maturity of two to three years, should be able to target a 1.50% to 2.00% return. The short maturities should help the portfolio avoid losses, even when interest rates are rising. Thus, they may be a solid alternative for your cash that does not need immediate liquidity.
Many mutual funds and ETFs use longer maturities and weaker credit ratings to generate a similar return. During periods of rising interest rates, longer maturity bonds mean more losses in your portfolio. During economic downturns or panicked markets, weaker credits mean more losses in your portfolio. Liquidity is a little easier in mutual funds and ETFs. Still, is it worth taking a lot more risk to earn a similar or lower return? I don’t think it is.
It is key that the mortgage-backed securities separately managed account be expertly managed. Smaller advisors can be more opportunistic.
Alas, finding this expert may be the hardest part of implementing this strategy. You really need a focused expert to find the pockets of opportunities. In addition, an MBS expert at a small firm can often be more opportunistic than a larger manager and capture more of the alpha that we discussed.
Consider this illustration. Imagine you are looking to buy a used car. You can go to a dealer and pay retail. What if, as an alternative, you can pay a small fee to an expert to buy the car for you in a used car auction at a dramatically lower price. As a bonus, the expert can better evaluate the risks associated with owning that car.
Under the right manager, an SMA of high-quality MBS has the potential to generate substantially more income than a money market account, CDs, or many short-term bond funds. As a bonus, an MBS separate account may have far lower risk and volatility than an ETF or mutual fund takes to earn a similar return.
For more details and a discussion of how an MBS SMA might benefit your overall asset allocation, look at my recent article, Protect Against Inflation And Earn Stable Income With Mortgage-Backed Securities
I am a new author. How can I help?
Please leave a comment with ideas that you would like to me to explore.
This article was written by
Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: This piece is filled with opinions that could be wrong. Any forward-looking statements should not be construed as being indicative of actual events that will occur. Performance will vary, and past results are not necessarily representative of future results. Investing involves risk of loss.

source