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FlexShare Adds to Their Lineup with New MBS ETF

Zacks Equity Research

After a brief pause, FlexShares, the ETF brand from Chicago-based Northern Trust, is back in the market to expand its lineup of products. Though the issuer has several ETFs in both the broad equity and the bond world, the issuer is looking to bring in new products targeting niche markets too.

With this focus, the issuer has come out with a brand new product – FlexShares Disciplined Duration MBS Index Fund (MBSD) – the first such mortgage-backed securities (MBS.V) fund for FlexShares.

The product charges 20 basis points annually as fees and will provide investors exposure to investment grade MBS (read: Guide To MBS ETF Investing).

While there is a bit of competition in this space, MBSD might still make a niche for itself. We have highlighted some of the key points regarding this new FlexShares fund below:

MBSD in Focus

The fund seeks to provide MBS exposure by tracking the BofA Merrill Lynch Constrained Duration US Mortgage Backed Securities Index. The index tracks the performance of U.S. dollar denominated 30-year, 20-year and 15-year fixed rate residential mortgage pass-through securities issued by U.S. government agencies including Fannie Mae, Freddie Mac and Ginnie Mae.

This approach results in the fund holding a basket of 56 securities holding Aaa (Moody's), AAA (Fitch) and AA+ (S&P) ratings. Securities issued by Fannie Mae form 38.16% of total fund assets, while those by Freddie Mac get 30.5% allocation and Ginnie Mae securities get 25.6% allocation.

The portfolio’s average effective duration will typically range between 3.25 and 4.25 years and the fund has a weighted average yield to maturity of 3.42%.

However, what makes the fund different from other MBS ETFs is that unlike other funds, MBSD seeks to limit duration extension and contraction variability caused by different factors including mortgage prepayments (read: 3 Ultra Safe Bond ETFs to Dodge Market Turmoil).

How does it fit in a portfolio?

The fund is a good choice for investors seeking exposure to mortgage backed funds to generate income and diversify their fixed income exposure. Moreover, the fund attempts to limit volatility caused by duration risk.

Most MBS ETFs have performed quite well this year thanks to a plunge in interest rates since the start of the year. Contrary to popular belief the Fed tapering didn’t lead to a hike in interest rates, making bond investing including MBS an attractive investment option.

Also, after a soft spring selling season, the housing market is picking up. The buyers are back in the market now that they are more confident of a recovering economy and an improving job market. Still-low interest rates act as a further stimulus for home buying in spite of the Fed scaling back its bond-buying program (read: Ride Out the Construction Boom with Housing ETFs).

ETF Competition

The MBS ETF space has very few options, though the newly launched fund will certainly face competition from the largest two players in the space – iShares Barclays MBS Fixed-Rate Bond Fund (MBB) and Vanguard Mortgage-Backed Securities ETF (VMBS).
MBB rules the space with an AUM size of $6.2 billion and an average trading volume of more than 350,000 shares a day. The fund tracks the Barclays Capital U.S. MBS Index to provide exposure to investment grade fixed-rate mortgage-backed pass-through securities of US agencies. The product charges 27 basis points as expenses.
VMBS, however, manages an asset base of $541.3 million but is the cheapest in the space with an expense ratio of 12 basis points (see all Mortgage-Backed Security ETFs here).
Thus Vanguard might be a strong competitor to the newly launched fund, given that the latter charges a little higher than VMBS. Nonetheless, MBSD is cheaper than the king in the space. Moreover, if the newly launch fund is indeed successful in its attempt to limit volatility caused by duration risk, it might have great days ahead and manage to build a sizable asset base as well.
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