30 May 2019
The landscape for mortgage-backed securities (MBS) has changed significantly since the subprime crisis, opening up interesting opportunities for investors. In a Q&A Tom Mansley and Gary Singleterry, specialising in MBS at GAM Investments, discuss the outlook for the market in 2019.
A decade has passed since the end of the subprime crisis and many of the old issues facing US MBS have been resolved. We believe that the MBS market can offer those investors seeking a truly diversified fixed income strategy enticing opportunities.
The MBS market came under the spotlight during the 2007-9 global financial crisis and the memory of this has meant some investors remain wary of the asset class. However we strongly feel not only has the MBS market evolved since then but the market offers investors a great way to address one of the major issues they are facing today - an environment where yields across traditional bonds are minimal, or even negative.
The asset class is extremely diversified and offers a wide spectrum of instruments that cater for various risk appetites and market environments. Certain types of MBS even have the potential to protect a fixed income portfolio from rising interest rates – this protection is not always possible with traditional bonds. The US MBS market is vast - at a size of USD 8 trillion it constitutes 23% of the US bond market and 15% of the global bond market, second only to US Treasuries. What has changed, however, is that the market is now much more robust than a decade ago and has considerably less systematic risk than previously.
We remain positive on the outlook for MBS in 2019. The legacy (pre-crisis) issues are proving beneficial or liquidating in a very predictable manner and have demonstrated to be relatively high yielding and stable investments during the last few years. Due to high underwriting requirements, mortgages issued in the aftermath of the crisis have been of a very high quality. We expect an increased volume of issuance in 2019, continued high quality and strong credit performance.
As a result of low unemployment, lower consumer debt to income levels, and rising home prices, the delinquency rate has declined to levels not seen since the 1990s (Chart 1).
Chart 1: Delinquencies as % of total loans SA
Past performance is not an indicator of future performance and current or future trends.
House prices in the US have recovered from their trough in 2011. The excess inventory and low demand of the 2007-2010 period has been corrected and we now have a healthy supply and demand situation in the housing market. The current inventory of homes available for sale is low, the rate of new home construction is still below the historical average, and there is healthy demand driven by increasing household formation and the tendency of newly formed households to purchase rather than rent homes since 2015.
House prices have been increasing at an average annual rate of about 6% per year since 2015 and are now back to their long-term trend. The rate of price increase has begun to slow, which is to be expected as the housing market returns to a balance between supply and demand and housing affordability stabilises. We expect the rate of price increase to continue to slow in the US and average about 3% per year for the foreseeable future. The US housing market also continues to improve in credit worthiness. Delinquency levels continue to fall, house prices are well supported and there continues to be strong demand for the MBS securities.
Global growth is slowing in many major economies. There has been a marked change in economic expectations during the first quarter of 2019, especially since the March meeting of the Federal Open Market Committee (FOMC), in anticipation of a slowdown or even recession in the US. While we expect a slowdown in the US economy, we believe that the housing market is in a strong position to weather such an event. According to a recent study by CoreLogic (The MarketPulse March 2019), house prices actually increased in three of the last five US recessions.
We do not see any major challenges facing the MBS market in 2019. We have a couple of minor concerns, one of which is the possibility of an economic slowdown in late 2019. This would put some pressure on employment and house prices, but we do not believe that this would impact the expected income we would receive on our investments.
In the residential mortgage market, we continue to favour non-agency bonds over government guaranteed agency securities. In the commercial sector, we favour apartment complexes and small balance commercial loans.
Overall, we feel there are three main points to stress: good yields, low volatility and low correlation with other asset classes.
The information in this document is given for information purposes only and does not qualify as investment advice. Opinions and assessments contained in this document may change and reflect the point of view of GAM in the current economic environment. No liability shall be accepted for the accuracy and completeness of the information. Past performance is no indicator for the current or future development.
Investments in the product mentioned in this material are speculative and involve a high degree of risk. An investor should not make an investment unless the investor is prepared to lose all or a substantial portion of the investment. The fees and expenses charged in connection with this product may be higher than the fees and expenses of other investment alternatives and may offset profits. Mortgage and asset-backed securities may be sensitive to changes in interest rates, subject to early repayment risk, their value may fluctuate in response to the market’s perception of issuer creditworthiness; while generally supported by some form of government or private guarantee there is no assurance that private guarantors will meet their obligations. Opportunities for withdrawal and transferability of interests are restricted such that investors may not have access to capital when it is needed. There is no secondary market for the interests and none is expected to develop. The Fund may not be highly diversified, and this lack of diversification may result in higher risk. Derivatives may involve certain costs and risks such as liquidity, interest rate, market, credit, management and the risk that a position could not be closed when most advantageous. Investing in derivatives could lose more than the amount invested. The use of leverage may cause a portfolio to liquidate positions when it may not be advantageous to do so to satisfy its obligations or to meet segregation requirements. Leverage, including borrowing, may cause a portfolio to be more volatile than if the portfolio had not been leveraged.