Van Eck Global yesterday introduced the Market Vectors Mortgage REIT Income ETF (MORT), a new ETF offering pure play exposure to mortgage REITs. The initial yield is expected to be in the double digits, but with mortgage rates near historical lows, it’s not at all clear how long MORT can support such high distributions.
The underlying Market Vectors Global Mortgage REITs Index (index fact sheet pdf) was launched only two weeks ago but was hypothetically backtested to 12/31/04. No yield information was found for either the fund or the index, so we performed our own analysis. The index yield averaged around 6% for the first four years (through the end of 2008) and then skyrocketed above 20% during the financial turmoil of 2008-2009. (Chart reprinted from the index fact sheet.)
The yield increase was due to falling prices, not rising dividends. As the index performance chart indicates, the price index declined more than 79% during the bear market. The dividends cushioned this somewhat, allowing the total return index to hold its losses to “just” 74%. Over the past year, the index has kicked out a yield of around 14%. However, you need to keep in mind that the original index level of 1000 is around 360 today. The 14% yield is based on the current index level. That translates to about a 5% yield-on-cost for anyone that bought the hypothetical original 6% yield (at an index level of 1000).
Current mortgage rates are less than 5%, implying that mortgage REITs must employ extremely high leverage to generate a 14% yield for shareholders. This of course adds leverage risk to the litany of risks already embedded in this market segment. With volatility and drawdown much greater than the S&P 500, mortgage REITs are also exposed to risk from real estate prices, interest rates, borrower credit, pre-payment, and other soruces. These risks can result in lower dividends, lower prices, higher volatility, or any combination of the above.
MORT holds 25 mortgage REITs with 21.0% allocated to Annaly Capital Management (NLY). Other large positions include American Capital Agency Corp (AGNC) 12.0%, Chimera Investment Corp (CIM) 7.4%, MFA Financial Inc (MFA) 6.1%, and Hatteras Financial Corp (HTS) 5.2%.
Expenses for MORT will be capped at 0.40%. Its prime competitor is iShares FTSE NAREIT Mortgage Plus Capped (REM) (REM overview page). REM boasts a 12-month yield of 10.4%, and like the underlying index for MORT, REM declined 75% during the 2007-2009 bear market and still trades at less than half of its peak value.
The yields on mortgage REIT ETFs are certainly enticing, but potential investors must open their eyes to the risks involved and have a plan for when those risks materialize. You can learn more about this market segment in Van Eck’s Investment Case for MORT. Additional information about the new fund is located in the press release, summary page, fact sheet, and prospectus.
Disclosure: covering writer, editor, and publisher: No positions in any of the securities mentioned. No positions in any of the companies or ETF sponsors mentioned. No income, revenue, or other compensation (either directly or indirectly) received from, or on behalf of, any of the companies or ETF sponsors mentioned.