mortgage simple definition: The ABCs of Mortgage-Backed Securities ETFs

The ABCs of Mortgage-Backed Securities ETFs

The ABCs of Mortgage-Backed Securities ETFs.

The ABCs of Mortgage-Backed Securities ETFs video duration 9 Minute(s) 1 Second(s), published by ETFs on 23 10 2017 - 12:43:57.

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In the aftermath of the 2008 financial crisis, mortgage-backed securities or MBS, weren’t exactly left with a stellar reputation. When the housing market collapsed, many of the investors who held such instruments took on major losses, a phenomenon that sent shock waves throughout the economy. But just a few years later, these fixed-income securities, which are supported by a pool of home loans, have made quite a comeback. Today, with roughly $9 trillion outstanding, they represent one of the biggest components of the United States bond market.
Some of that growth is driven by individual investors, who can more easily tap the MBS market than ever before. That is because they have access to several exchange-traded funds (ETFs) that focus exclusively on mortgage securities. For those who seek diversification in their portfolio – and are willing to do a little homework – such funds might be worth a look.
MBS basics
Before investing in one of these ETFs, it is important to understand what a mortgage-backed security is. MBS are created when an entity buys a bundle of mortgages and then sells securities that give the investor a claim to the cash flow on these loans. Most MBS are pass-through securities, meaning the principal and interest payments each month pass through the securities issuer to the investor.
If you are thinking about buying shares of an ETF, one of the first things you will want to know is where the fund is buying its mortgage-related securities from. Most funds target securities from one of three agencies: Ginnie Mae, Fannie Mae and Freddie Mac.
Ginnie Mae securities are considered the safest. As a federal agency, its financial obligations are backed by the full faith and credit of the US government. Those sold by Fannie and Freddie, both publicly owned government-sponsored enterprises, do not enjoy quite that level of protection. Nonetheless, they are thought to come with an implicit backing from the government.
Because ETFs tend to focus on these agency MBS, the credit quality of the underlying loans also tends to be quite high. Fannie Mae and Freddie Mac only securitize conventional loans that conform to their relatively conservative guidelines. Ginnie Mae resells mortgages that are insured or guaranteed by the federal government, including Federal Housing Administration and Veterans Affairs home loans. So ETF investors can take heart: you are unlikely to find the risky subprime and Alt-A mortgages that wreaked so much havoc when the housing bubble collapsed.
Some banks, brokerage houses and home builders also securitize home loans. Because these do not come with a guarantee from the government, these private label mortgage securities usually offer slightly higher yields in order to entice investors. However, these tend to comprise a very small percentage of ETF holdings.
Why invest?
Part of the appeal with ETFs is that they make it much easier to access the mortgage-based bond market, wh