The real estate sector has been attracting a lot of investor attention lately. Concerns over Fed’s stance on monetary policy have been bothering the sector because if the interest rates are hiked faster than anticipated, it will weigh on people’s ability to borrow.
Mortgage REITs borrow money at short-term interest rates and when they buy mortgages, they lend it at rates near the higher long-term rates. Their lucrative dividends set them apart from traditional fixed income and money market securities. However, they underperform in a rising-rate environment, as an increase in mortgage rates hampers the performance of the sector, as home loans become costlier and demand falls.
U.S. markets recently suffered a sell-off owing to fears of rising rates. The S&P 500 entered correction territory, as it declined more than 10% from the record high set in January. Strong wage growth and jobs data introduced fears of inflation making a comeback and led investors to bet on aggressive rate hikes.
Consumer prices increased 2.1% year over year in January, unchanged from the previous month but above economists’ forecasts of 1.9%. Moreover, President Donald Trump’s tax reform and spending deal might add further pressure on prices. Hence, the Fed is expected to hike interest rates multiple times this year to tame inflation. Given this, markets are betting on the Fed to hike rates more than three times suggested earlier. Per the CME Fed Watch tool, there is an 83.1% chance of a 25 basis point rate hike in March (read: Are TIPS ETFs the New Safe Haven?).
Let us now discuss two ETFs focused on providing exposure to the sector.
iShares Mortgage Real Estate ETF (REM - Free Report)
This fund seeks to provide exposure to the mortgage REIT space and tracks the FTSE NAREIT All Mortgage Capped Index. It has AUM of $1.0 billion and charges a fee of 48 basis points a year. It has 37 holdings and bears significant concentration risk as more than 70% of the assets are allocated to the top 10 holdings.
The fund’s top three holdings are Annaly Capital Management REIT Inc (NLY - Free Report) , AGNC Investment REIT Corp (AGNC - Free Report) and New Residential Investment REIT Co (NRZ - Free Report) with 17.9%, 11.1% and 8.2% allocation, respectively (as of Feb 16, 2018). The fund has returned 6.0% in a year but has lost 5.4% year to date. REM has a Zacks ETF Rank #3 (Hold), with a Medium risk outlook.
VanEck Vectors Mortgage REIT Income ETF (MORT - Free Report)
This fund seeks to provide exposure to mortgage REIT space and tracks the MVIS Global Mortgage REITs Index. It has AUM of $133.1 million and charges a fee of 41 basis points a year. It has 26 holdings and bears concentration risk as more than 63% of the assets are allocated to the top 10 holdings.
The fund’s top three holdings are Annaly Capital Management REIT Inc, AGNC Investment REIT Corp and Starwood Property Trust Inc (STWD - Free Report) with 14.0%, 8.5% and 6.0% allocation, respectively (as of Feb 16, 2018). The fund has returned 6.3% in a year but has lost 5.7% year to date. MORT has a Zacks ETF Rank #3, with a Medium risk outlook.
REM is more popular than MORT, as is evident from its higher AUM. However, MORT may be more appealing to investors owing to its cheaper expense ratio.
At the same time, both the funds have had relatively similar year-to-date performance. REM has lost a mere 0.3% less than MORT so far this year, whereas in a year, it underperformed MORT by 0.3%. U.S. housing starts increased 9.7% to 1.326 million units in January, the highest since October 2016, per the Commerce Department. However, rising mortgage rates and housing prices may weigh on the momentum.
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