Investors Tap Mortgage Bond ETFs for Yield, Rate Protection

An ETF that invests in government-sponsored mortgage bonds has been seeing healthy inflows in recent weeks from investors who want some protection if interest rates rise.

Over the past month, iShares MBS Bond ETF (MBB) has raked in $443 million and trading volume has picked up lately, according to WallachBeth Capital.

MBB has a 30-day SEC yield of 2.8% while 10-year Treasury notes are yielding less than 1.7%.

The ETF tracks U.S. agency mortgage-backed bonds, including Fannie Mae, Freddie Mac, and Ginnie Mae securities. The fund has an expense ratio of 0.26% and holds $6.7 billion of assets.

“Their low average duration has historically made mortgage bonds one of the best bond categories to own in a rising interest-rate environment,” says Morningstar analyst Timothy Strauts. “Considering that many people are fearful of rising interest rates, mortgage bonds could become an increasingly popular option for those seeking to mitigate the effects of rising interest rates while still collecting a competitive yield.”

MBB has an effective duration of 2.8 years, according to manager BlackRock (BLK).

Of course, Treasury yields have been trending lower the past two months but some investors continue to position for higher interest rates with shorter-duration bond ETFs and floating-rate funds, for example.

“Government-sponsored mortgage bonds typically sport higher yields than comparable U.S. Treasury bonds,” Strauts explains in a profile of MBB. “However, because homeowners can refinance or sell their homes at any time, mortgage-bond cash flows are very unpredictable. This ‘prepayment risk’ is why these bonds pay higher interest rates.”

Other ETFs in the category include SPDR Barclays Capital Mortgage Backed Bond (MBG) and Vanguard Mortgage-Backed Securities Index ETF (VMBS).