Widows, Orphans And mREITs

Includes: AGNC, ANH, CMO, HTS, NLY
by: John Gerard Lewis

The cadre of mREIT analysts is never not abuzz about whether the out-of-sight dividends are sustainable. This is understandable, as high payouts are the raison d'etre of mortgage real estate investment trusts and the lure for those who buy their shares.

The obsession with yields is matched by hope that the share prices remain relatively stable, varying no more than a few percentage points during the holding period, so as not to undercut total returns.

Is this anxiety-riddled preoccupation worthwhile? Well, it certainly can be worthwhile over limited periods of time, during which the investor holds his breath until the ex-dividend date passes and he has survived with a positive return. It's not unlike waiting for an option to expire. Whew!

Of course, the opposite experience is also on the table. The share price has every opportunity to drop over time by more than the holding period's dividend payout.

A separate common strategy for investing in mREITs is scheduled quarterly trading, i.e., buying immediately after the ex-date, when the share price typically craters, and waiting to sell until after the usual run-up prior to the next ex-date. Of course, neither is that strategy foolproof, as an endogenous or exogenous company event could hammer the shares at any given time.

With either strategy, the quarterly cyclicality of the beast thus causes us to watch that dividend closely, and our collective investment approach is hypersensitive to its perceived fate.

Therefore, in every respect, the universal counsel is that, like all other ultra-high-yield offerings, mREITs are not for widows and orphans. If you can't resist, we're gravely advised, then do so with the tiniest of allocations.

It would thus seem that mREITs are suitable only for risk capital - play money - and even then only for relatively short-term trading. But is this true? Can mREITs, to the contrary, be prudent long-term investments? Can an investor buy a basket of these things and forget about them for a couple of years?

It appears that they can. We found that over the past several years, the average total return for five representative mREITs, held for various intervals of 24-months, was 52%. And during the study period, dividends were irregularly raised and reduced by all five companies.

The analysis covered the period from May 2008 to December 2011. In order to attenuate the effect of the quarterly price run-up phenomenon, we assumed purchases and sales occurred in the middle of calendar quarters.

Of course, the five companies - American Capital Agency Corp. (NASDAQ:AGNC), Capstead Mortgage Corp. (NYSE:CMO), Anworth Mortgage Asset Corp. (NYSE:ANH), Hatteras Financial Corp. (NYSE:HTS) and Annaly Capital Management, Inc. (NYSE:NLY) - didn't each produce the same magnitude of return. The high-end outlier was AGNC, with an average return of 97% for each 24-month interval. At the bottom was Capstead Mortgage CMO, with a still impressive average return of 37%. But even without the boost from AGNC, the average return for the other four was 41%.

Still, these are rather exotic creatures, and how well might you sleep at night? Presumably, pretty well. The group's collective price stability, the other component of total return and a critically important one for high-yielding securities, is remarkably satisfactory with an average beta of just 0.28 (72% less volatile than the overall market).

Thus, if Grandma had pulled the trigger back in '08, she could now quite reasonably argue to nail-biting heirs that her investment in mREITs proved both sound and appropriate. We don't think they'd agree, but she could make the argument.

Of course, future isn't past and we're loath to discount the conventional caution. But the evidence suggests that mREITs might qualify as long-term investments after all.

Disclosure: I am long AGNC, ANH, CMO, HTS, NLY.