Agency MBS salvaged 2023 with an impressive fourth quarter performance. The sharp decline in interest rates and the December Fed pivot provided welcome relief to underwater bank portfolios, and reduced fears of further fixed-income fund outflows. While mortgages trailed other subsectors of the Bloomberg U.S. Aggregate Bond Index for the entirety of 2023, investors who allocated to the sector at the end of the third quarter when valuations were historically attractive were able to capture significant outperformance as the Bloomberg U.S. MBS Index total and excess returns went from negative territory to 5.05 percent and 0.70 percent, respectively. MBS valuations have since normalized relative to recent wides but as of Jan. 30, still yield 5–5.5 percent, roughly 1.4 percent above Treasurys.
Rather than focusing on the timing and extent of future Fed rate cuts, we recommend positioning for the eventual realization of lower short-term interest rates over the medium to long term. We favor 5–5.5 percent coupon MBS at $95–$100 prices, which offer wider nominal spreads, higher yields, and more favorable exposure to falling interest-rate volatility relative to the lower coupon MBS that dominate the index. If rates move lower, 5–5.5 percent coupon MBS allow for price appreciation due to their lower sensitivity to increases in prepayment rates relative to MBS currently priced above $100. Since these MBS are priced to relatively low prepayment speeds, they also carry less extension risk if mortgage rates retrace their recent highs.
Among $95–$100 priced MBS, we also see an opportunity to monetize the price appreciation in MBS-specified pools—MBS backed exclusively by loans with favorable prepayment attributes—that occurred over the past quarter. Selling specified pools in favor of buying generic, new production MBS pools both potentially boosts yield and increases exposure to falling interest rate volatility. Meanwhile, in contrast to single-family mortgage MBS, spread volatility in Agency CMBS has been muted, which has limited relative value opportunities. Supply has shifted into shorter tenors and the dearth of long duration origination has flattened the spread curve in the sector. As a result, we favor adding long duration via single-family collateralized mortgage obligation (CMO) structures that offer both wider spreads and higher yields relative to multifamily offerings.
This material is distributed or presented for informational or educational purposes only and should not be considered a recommendation of any particular security, strategy or investment product, or as investing advice of any kind. This material is not provided in a fiduciary capacity, may not be relied upon for or in connection with the making of investment decisions, and does not constitute a solicitation of an offer to buy or sell securities. The content contained herein is not intended to be and should not be construed as legal or tax advice and/or a legal opinion. Always consult a financial, tax and/or legal professional regarding your specific situation.
This material contains opinions of the authors, but not necessarily those of Guggenheim Partners, LLC or its subsidiaries. The opinions contained herein are subject to change without notice. Forward-looking statements, estimates, and certain information contained herein are based upon proprietary and non-proprietary research and other sources. Information contained herein has been obtained from sources believed to be reliable but are not assured as to accuracy. Past performance is not indicative of future results. There is neither representation nor warranty as to the current accuracy of, nor liability for, decisions based on such information.
Investing involves risk, including the possible loss of principal. In general, the value of a fixed-income security falls when interest rates rise and rises when interest rates fall. Longer term bonds are more sensitive to interest rate changes and subject to greater volatility than those with shorter maturities. During periods of declining rates, the interest rates on floating rate securities generally reset downward and their value is unlikely to rise to the same extent as comparable fixed rate securities. High yield and unrated debt securities are at a greater risk of default than investment grade bonds and may be less liquid, which may increase volatility. Investors in asset-backed securities, including mortgage-backed securities and collateralized loan obligations (“CLOs”), generally receive payments that are part interest and part return of principal. These payments may vary based on the rate loans are repaid. Some asset-backed securities may have structures that make their reaction to interest rates and other factors difficult to predict, making their prices volatile and they are subject to liquidity and valuation risk. CLOs bear similar risks to investing in loans directly, such as credit, interest rate, counterparty, prepayment, liquidity, and valuation risks. Loans are often below investment grade, may be unrated, and typically offer a fixed or floating interest rate.
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*Assets under management is as of 3.31.2024 and includes leverage of $14.5bn. Guggenheim Investments represents the following affiliated investment management businesses of Guggenheim Partners, LLC: Guggenheim Partners Investment Management, LLC, Security Investors, LLC, Guggenheim Funds Distributors, LLC, Guggenheim Funds Investment Advisors, LLC, Guggenheim Corporate Funding, LLC, Guggenheim Partners Europe Limited, Guggenheim Partners Japan Limited, and GS GAMMA Advisors, LLC.