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Mortgage REITs ("mREITs") buy mortgage paper as an investment, or in order to re-securitize them and sell them to another mREIT or some other entity that is investing in real estate loans. Most mREITs specialize in buying and trading mortgage backed securities ("MBSs"), and especially agency MBSs. Most mREITs are known for their high yields.
Agency mREITs buy mortgage paper that is backed by federal agencies. Non-agency mREITs hold mortgage paper without such a government agency backing, though these companies also can and do buy large positions in agency paper. Non-agency mREITs are also sometimes called hybrid mREITs if they also own agency paper. The vast majority of recent U.S. residential mortgage originations has been purchased, guaranteed or insured by the federal government. As a result, most non-agency mREITs are now hybrid mREITs.
There are many differences between these mREITs in terms of their portfolio & hedging strategies, leverage rates and exposure to various risks. It also appears that there are just as many opinions on which mREIT is the best right now and for the long term. For those who aren’t interested in picking a single equity, but prefer to invest broadly within mREITs in order to obtain some high-yield, there are two ETFs that offer high-yield mREIT exposure: the iShares FTSE NAREIT Mortgage REITs Index ETF (NYSEARCA:REM) and the Van Eck offers the Marker Vectors Mortgage REIT Income ETF (NYSEARCA:MORT).
REM currently provides a yield of 10.45 percent. MORT is a fairly new ETF, having been launched in the middle of August. On Friday, September 30, 2011, Van Eck announced a 68 cent quarterly dividend for MORT, but this dividend only includes income from the first day of its trading, which was pretty much right in the middle of the quarter. This single dividend would be about a 2.9 percent payout, indicating that MORT will likely have a higher yield than REM in the coming quarters.
Comparing the holdings of the two ETFs, there are some significant similarities and some significant differences. Below, I have prepared a chart of the top 10 holdings of the MORT ETF, and compared their weightings within that ETF to their weightings in REM.
Annaly Capital Management (NYSE:NLY)
American Capital Agency (NASDAQ:AGNC)
Chimera Investment (NYSE:CIM)
Hatteras Financial (NYSE:HTS)
MfA Financial (NYSE:MFA)
Two Harbors Investment (NYSE:TWO)
Starwood Property Trust (NYSE:STWD)
Cypress Sharpridge Investments (NYSE:CYS)
Capstead Mortgage Corp (NYSE:CMO)
Invesco Mortgage Capital (NYSE:IVR)
Total Percent:
The top three holdings are the same for these two mREIT ETFs, and account for over one-third of REM’s total holdings and over 40 percent of MORT’s. MORT has 25 holdings, while REM has 48. Nonetheless, the top ten holdings of each accounts for the majority of their respective portfolios. In fact, MORT’s top 10 holdings account for 55.99% REM’s portfolio, even though four of those mREITs are outside REM’s top 10. REM’s top 10 accounts for about 64% of its total holdings.
Though the trading history of MORT is fairly limited, it appears to be acting better than REM over the last week. After underperforming REM for about a month, the trend reversed last week. This may have to do with MORT's greater exposure to the high-yield mREITs. See the chart below - (click to enlarge):
Additionally, REM has an expense ratio of 0.48%, while MORT has a 0.40% expense ratio. Therefore, it appears that MORT will have a higher yield and lower fees than REM, going forward. MORT does have a less diverse portfolio, though, and will likely have greater risk to leveraged spreads. Several of REM’s larger holdings are not of the ultra-high yield variety, and those may eventually raise their yields or appreciate to a greater degree than the high yield mREITs usually would.
Most mREITs rely on a spread between borrowing costs and investment yield. Wide spreads usually generate larger operating margins for mREITs, while narrow spreads reduce margins. Many mREITs, especially within the agency MBS business, rely heavily upon leverage. This reliance makes mREIT margins sensitive to changes in interest rates, where rate-hikes increase borrowing costs and reduce margins. Prepayment of mortgages can also compress margins. Prepayments tend to increase in a low-rate environment.
Mortgage REITs offer significant yield and some very real and understandable risks. Exposure to mREITs should be limited to a reasonable percentage of a portfolio. Additionally, REIT dividends are taxed as ordinary income, and not at the qualified dividend rate that corporate dividends receive, making them considerably superior-performing products when held in tax-free accounts.
Disclosure: I am long NLY, CIM.
Disclaimer: This article is intended to be informative and should not be construed as personalized advice, as it does not take into account your specific situation or objectives.
Source: A Comparison Of The High-Yield mREIT ETFs And Their Holdings