Mortgage-backed securities offer high-quality income and are relatively cheap, UBS says

Published Mon, Apr 8 20242:32 PM EDTUpdated Mon, Apr 8 20243:37 PM EDT

Investors looking for high-quality income, as well as a bargain, should turn to agency mortgage-backed securities, according to UBS. The bank thinks the securitized products are relatively cheap compared to investment-grade corporate bonds, said Leslie Falconio, head of taxable fixed income strategy in UBS Americas' chief investment office. They also have current yields around 5.7%, she told CNBC in an interview Friday. Agency MBS are debt obligations backed by the government and are issued by agencies such as Fannie Mae, Freddie Mac and Ginnie Mae. Their cash flows are tied to the interest and payment on a pool of mortgages. "This is a triple-A asset class with pretty much no credit risk and a tremendous amount of liquidity at a time when we are not expecting a hard landing and we do expect the economy to slow," Falconio said. When the Federal Reserve paused its interest rate hikes last fall, and it became apparent rates were at their peak, all fixed income did well, she explained. However, agency MBS lagged their higher-quality counterparts because they are highly correlated to interest rate volatility, she said. "The tailwind we saw in 2023 that allowed high-yield and investment-grade corporate credit to do well did not spill over to mortgage credit until starting this year," Falconio said. "They are cheap on a relative value basis." She specifically likes current-coupon mortgages. Investors can play the space by using exchange-traded funds. The iShares MBS ETF (MBB) has a net expense ratio of 0.04% and a 30-day SEC yield of 3.54%. The Janus Henderson Mortgage-Backed Securities ETF (JMBS) touts a 30-day SEC yield of 5.37% and carries a net expense ratio of 0.23%. While there will be some continued interest rate volatility in the short term, as the market reacts to different data points, that should decline over the course of the year, she said. As gross domestic product slowly trends lower, the market will become more comfortable with the likelihood of the Fed cutting rates, Falconio said. Interest rates will move lower and MBS, as a cheaper option, are going to benefit from inflows, she predicted. Banks, which have been investing excess deposits in Treasurys, will be among those turning to agency MBS, Falconio said. Banks will see rising deposits and weaker loan growth as the economy slows, and they will turn to MBS to lock in higher yields, she said. In addition, the negative effect of the inverted yield curve on agency MBS will reverse this year. UBS thinks the yield curve will normalize and by the end of the year could be slightly upward sloping.