After spending the prior two years at historically rich valuations driven by accommodative Federal Reserve policy dominating the market, the combined effects of reduced bank buying, increased interest rate volatility, poor technicals associated with FDIC selling and the historic inversion of the treasury yield curve have in our view left mortgages at their most attractive level in years. We maintain that mortgage-backed securities (MBS) have become an attractive relative value alternative to investment grade (IG) credit in the face of increased economic uncertainty and the direction of Federal Reserve interest rate policy.
Supply concerns remain muted. Recent trading has been dominated by the supply technical of the FDIC’s liquidation of Silicon Valley Bank’s and Signature Bank’s portfolios. While sales went better than expected, concern over additional forced bank liquidations have not fully dissipated. Conversely, elevated mortgage rates and the associated constraint on housing affordability are likely to limit new origination and refinancing supply.
Mortgage performance contrasts sharply with IG credit, which is trading well inside the recent wide supporting relative value considerations when considering MBS as an alternative (See Figure 1).
Figure 1: MBS Current Coupon Spread Against the US Intermediate Index
Additionally, a future steepening of the yield curve would likely benefit MBS while pressuring IG credit given the economic slowing such a move would imply.
The rise in interest rates over the past 18 months has extended mortgage duration and improved the convexity profile of the asset class, though an uptick in volatility remains a risk to the sector.
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MacKay Shields LLC is a wholly owned subsidiary of New York Life Investment Management Holdings LLC, which is wholly owned by New York Life Insurance Company. "New York Life Investments" is both a service mark, and the common trade name of certain investment advisers affiliated with New York Life Insurance Company. Investments are not guaranteed by New York Life Insurance Company or New York Life Investments.
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About Risk
The principal risk of mortgage-related and asset-backed securities is that the underlying debt may be prepaid ahead of schedule, if interest rates fall, thereby reducing the value of the fund’s investment. If interest rates rise, less of the debt may be prepaid and the fund may lose money
NOTE TO UK AND EUROPEAN AUDIENCE
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NOTE TO CANADIAN AUDIENCE
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COMPARISONS TO AN INDEX
Comparisons to a financial index are provided for illustrative purposes only. Comparisons to an index are subject to limitations because portfolio holdings, volatility and other portfolio characteristics may differ materially from the index. Unlike an index, individual portfolios are actively managed and may also include derivatives. There is no guarantee that any of the securities in an index are contained in any managed portfolio. The performance of an index may assume reinvestment of dividends and income, or follow other index-specific methodologies and criteria, but does not reflect the impact of fees, applicable taxes or trading costs which, unlike an index, may reduce the returns of a managed portfolio. Investors cannot invest in an index. Because of these differences, the performance of an index should not be relied upon as an accurate measure of comparison.
The following indices may be referred to in this document:
Bloomberg US Intermediate Index
The Bloomberg US Intermediate Index measures the investment grade, US dollar-denominated, fixed-rate, taxable corporate and government-related bond markets with a maturity greater than 1 year and less than 10 years. It is composed of the US Corporate Index and a non-corporate component that includes non-US agencies, sovereigns, supranational and local authorities constrained by maturity.
Current Zero Volatility Spread
The Zero-volatility spread (Z-spread) is the constant spread that makes the price of a security equal to the present value of its cash flows when added to the yield at each point on the spot rate Treasury curve where cash flow is received.
Roll-adjusted 5 year cdx
The credit default swap index (CDX), formerly the Dow Jones CDX, is a benchmark financial instrument made up of credit default swaps that have been issued by North American or emerging market companies.
“Bloomberg®”, “Bloomberg Indices®”, Bloomberg Fixed Income Indices, Bloomberg Equity Indices and all other Bloomberg indices referenced herein are service marks of Bloomberg Finance L.P. and its affiliates, including Bloomberg Index Services Limited (“BISL”), the administrator of the indices (collectively, “Bloomberg”) and have been licensed for use for certain purposes by MacKay Shields LLC (“MacKay Shields”). Bloomberg is not affiliated with MacKay Shields, and Bloomberg does not approve, endorse, review, or recommend MacKay Shields or any products, funds or services described herein. Bloomberg does not guarantee the timeliness, accurateness, or completeness of any data or information relating to MacKay Shields or any products, funds or services described herein.
“New York Life Investments” is both a service mark, and the common trade name, of certain investment advisors affiliated with New York Life Insurance Company.
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