Risky Mortgage Bonds Making a Comeback: Pro

The U.S. housing market is showing signs of recovery and investors should be looking at non-agency mortgages, the very asset class that prompted the global financial crisis, according to Gregory Perdon, Co-Chief Investment Officer at Arbuthnot Latham & Co.

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“You’re seeing all the evidence pointing to the beginning of a housing recovery, “ he told CNBC Thursday. “[Investors] should be turning their attention to the non-agency market. In essence trying to capture the credit, which is the exact type of risk that we think is going to rise with the tides as we slowly recover.”

Residential mortgage-backed securities (RMBS) pay interest to investors from mortgage payments on home loans. There are two types of RMBS, agency-backed which are guaranteed by the U.S. Government and non-agency backed, which aren’t and therefore carry a greater risk.

It’s these non-agency backed securities that Perdon says investors should be looking at.

“A lot of investors don’t understand that the agency market really is a play on the yield curve. Essentially you’re expressing a carry trade,” he said, explaining that investors were able to borrow at extremely cheap rates to buy government-guaranteed bonds that paid a higher rate.

“In reality what investors should be doing in our view, to express a pro-housing view, is they should be turning their attention to the non-agency market.”

Excesses in the mortgages bond market are blamed for creating the U.S. housing collapse that triggered the 2008 financial crisis. But riskier mortgage bonds have been rallying recently as investors search for yield.

A report by the firm shows that all indicators point to a recovery in the U.S. housing marketand Perdon is adamant that the US. Federal Reserve is orchestrating this move.

“It’s very fashionable to say ‘look the world’s going to end’”, he said.

“It’s not a 100 percent guarantee, but everything is suggesting that credit quality, instruments, securities which are correlated to an increase in credit quality in America should appreciate in value over the coming years.”

“We’re in a scenario where clearly the Fed (U.S. Federal Reserve) action — they want to orchestrate a recovery in the housing market. That’s absolutely crystal clear. All you need to do is look at the mortgage rates,” he said, explaining that thirty year mortgage rates have dropped from 7 percent to close to 3.6 percent and the U.S. home prices have risen 3 to 4 percent year-to-date.