Sheridan Admans explains why he is investing in the GAM Star MBS Total Return fund in the TC Share Centre Multi Manager Cautious fund and the reasons behind that decision.
Why we've added GAM Star MBS Total Return to our funds
I have been in search of risk assets for some time that have a low correlation to other risk assets while delivering high risk adjusted returns; assets that provide ample liquidity, duration flexibility and exposure to US growth where active management can really take advantage of opportunities.
I have therefore sought to introduce the GAM Star MBS Total Return fund to our TC Share Centre Multi Manager Cautious fund. With the extensive experience of the management team on the fund, we are of the view that they have the right tools to successfully manage the current interest rate cycle.
Mortgage-backed securities (or MBS as they are more commonly known) are bonds that represent a bundle of mortgages that investors can buy. An MBS is an asset backed security that is secured on a mortgage or a group of mortgages. To free up capital, the bank packages the loans up and sells them to investors via investment banks.
MBS was not very familiar to UK investors until highlighted by the financial crisis of 2008. While unsavoury to some, the asset class does provide significant opportunities that are hard to overlook when constructing a diversified investment portfolio.
The MBS market represents approximately 24% of the US fixed income market. It is possible to get a significantly higher yield from MBS than offered by US Treasuries that have similar maturities, which includes higher quality Agency and Non-Agency bonds. Agency refers to government supported issuers of mortgages like Freddie Mac and Fannie Mae that guarantee mortgages. Non-Agency are those issuers that are not guaranteed. Arguably higher yields come with little or no additional risk from holding positions in both Freddie Mac and Fannie Mae. The MBS market is highly liquid with approximately $200 billion traded daily and has a market size of around $8 trillion.
Looking at the US housing market it has been recovering and has seen homeowner vacancy rates fall significantly since its peak in 2008, single family housing under construction is below its long-run average, homeownership rates have started to pick up once more since their collapse and housing affordability has been improving.
The asset class has gained a reputation due to the role sub-prime played in the financial crisis and while some of those risks have faded others remain; such risks as mortgage holders defaulting in large numbers or property values falling significantly, as a result of mismanagement of the US economy or the return to a softer regulatory environment. The other and main risk is prepayment risk. Prepayment risk is the early payment of the loan on the mortgage, not dissimilar to a callable bond.
The GAM team come with a great deal of experience and expertise understanding and evaluating the impact of interest rate changes, credit risk and mortgage prepayment behaviour. This has been clearly demonstrated having managed three US interest rates cycles, which include the peak of 5.25% in 2006 to the historic low of 0.25% in 2008 and delivered positive returns since 2002.
The managers currently have duration on their portfolio of 1.24 years and can flex between -3% and +3%. The average coupon in the portfolio is 2.96% with the average life of mortgages held at around 4.5 years.
All information given including prices, yields and our opinion is correct at the time of publication. Our opinions on investments can change at any time and for our latest view please go to www.share.com. To understand how our Investment research team arrive at their views please read our Investment Research Policy.