Mortgage ETF: Hoping That People Pay Off Their Loans

A mortgage ETF from Barclays launched a while ago amid concerns that the sub-prime mortgage market was in disarray. The iShares Lehman MBS Fixed-Rate Bond Fund (MBB) provides exposure to mortgage-backed securities.

These securities are essentially, “bonds that represent a claim on the principal and interest from the loans, and tend to pay out a higher yield than comparable quality government or corporate bonds,” writes John Spense. In addition, “mortgage-backed securities have higher yields to compensate investors for so-called prepayment risk. When interest rates decline, home owners often pay off their loans early, refinance their mortgages or buy a bigger house, so holders of mortgage-backed securities have some uncertainty about the timing and amount of their payments.”

It's important to note that this ETF does NOT hold the riskier sub-prime loans that are indicative of lower-income home buyers with generally weak credit scores. Rather, this ETF tracks an index of investment grade, fixed-rate mortgage backed securities of government sponsored mortgage issuers Ginnie Mae, Freddie Mac, and Fannie Mae. The index includes 30-, 20-, 15-year and “balloon” securities that have a remaining maturity of at least one year and have more than $250 million of outstanding face value.

Over 99% of the holdings are rated AAA by both Moody's and Standard & Poor.The expense ratio is 0.25% which is relatively low for this type of fund.

I'll be passing on this ETF. While interesting and possibly a good diversification tool, I already own the Barclays Lehman Aggregate Bond ETF (AGG) and the new mortgage ETF actually represents a subset (35%) of AGG.