If we take a look at a medium-term chart (reproduced below) for Annaly Capital Management (NYSE:NLY) or American Capital Agency Corp (NASDAQ:AGNC), we quickly observe something weird. These equities keep having quick crashes over and over again in the last couple of years.
Why is this so?
In a way, this happens because of the nature of the business mREITs operate in. mREITs are basically levered portfolios of MBS (Mortgage Backed Securities). And MBS, in the event of higher rates, behave like long duration fixed income assets.
That is, when rates threaten to go up, mREITs behave mostly like a 6-10 times levered portfolio of long duration fixed income. And as we've long known, when rates to up, fixed income bond prices go down to reflect the higher rates.
It's thus no surprise that every time rates seem to be going up, holders of these assets liquidate them, thus leading to lower prices.
But it doesn't stop there.
There is one more reason why mREITs behave this way, crashing often. This has to do with something that's happening in the market. Basically speaking, the rush for yield doesn't stop when people have fully invested.
No, many investors think they have found a free lunch. After all, if a stock like Annaly yields 13.3%, why not take out a loan or go into margin debt at 3, 4%, and pocket the difference? For sure, Annaly could even drop its dividend over and over again, and still produce a positive carry.
So that's what investors do. They go and lever up their purchases of mREITs and other similar, "yielding" assets. A model which, by the way, is not much different from what the mREITs themselves do regarding MBS.
So what do people end up with? They end up with a leveraged bet on an equity slice of a leveraged portfolio! And it is that leverage that, every time there's some liquidation in the underlying assets, quickly produces forced liquidation and a crash in the assets.
Again and again, we observe rapid crashes in the stocks of mREITs. These quick crashes are a result not only of the mREIT business model, but also of the attitude investors have taken regarding these stocks.
Sensing a possible "free lunch" In the ability to cheaply lever up portfolios of these high-yielding mREIT stocks, investors create margined portfolios of these equities. Naturally, many of those portfolios are so levered that each time the market has a correction in the space, forced liquidation of the margined portfolios produces quick crashes.
It's also noteworthy that these levered portfolios of mREITs are basically a levered bet on the equity tranche of a levered portfolio. It's a situation which, were it not for monetary manipulation by the Federal Reserve, would be more than likely to produce many bankruptcies, both at the portfolio level and in the mREITs themselves.