So now it’s Lehman Brothers in the hot seat. Lehman stock is off by 50 percent this year—almost 20 percent just this week. Apparently, the firm is going to join the write-down party, announcing huge losses on bets on mortgaged-backed securities. Lehman is asking for $4 billion or so in fresh capital.

Another Bear Stearns? Investors are scared, and their concern is spreading, pulling down the rest of the market. So what are some select institutions doing? Bottom fishing. Non-agency and agency-backed mortgages have attracted institutional buyers looking for value for the last several months. Because volatility is raging, you haven’t missed out; institutional investors say attractive entry-points are still forthcoming.

Some recent buyers of note have been PIMCO’s Bill Gross, who after catching flack for lagging his peers in 2006 while avoiding riskier debt, led the pack in 2007 (he was Morningstar Fixed Income Manager of the Year in 2007) with his Total Return Fund, the world’s largest bond fund with $128 billion in assets. Other contrarians include First Pacific Advisors’ New Income Fund as well as TCW manager Jeffrey Gundlach, who won the Morningstar award in 2006.

These managers and others have contributed to a turnaround in asset flows into mortgage bond funds. In fact, according to data provided by Strategic Insight, a New York research firm, money rushed into mortgage bond funds in the first four months of 2008. That’s notable since the funds had suffered negative flows for nearly 48-straight months.

According to published reports, Gross shifted more than 60 percent of Total Return’s assets into agency-backed mortgage debt in the first quarter of this year, a move that has no doubt helped his fund’s returns. According to Morningstar, PTTAX is up 11.8 percent over the last 12 months and 3.07 percent so far this year, putting the fund in top few percent of its category.

Julian Mann, an analyst and vice president at First Pacific Advisors, says his firm is taking a more cautious approach to the market. He describes his firm as a deep value shop and says his fund, the New Income Fund (FPNIX), is investing only in agency-backed debt, having completely exited even the high-quality sectors of non-agency debt in the Spring of 2005. He spoke about the attractiveness of agency-backed mortgage securities in blunt terms. “Let’s put it this way, everything else is unattractive,” says Mann. “When you have a Treasury curve that’s through inflation, when you’re going into arguably a period of economic weakness, if not recession, then you’d expect credit spreads to be wider. So you’re almost in a situation where the best thing you can buy is some seasoned mortgage paper [he refers to Fannie, Freddie and Ginnie Mae] in terms of pure value, getting a positive real rate of return,” he says. “I’m not saying we wouldn’t like to buy other things, but they’re too rich.”

Over at TCW, chief investment officer and lead portfolio manager of the Total Return Fund (TGLMX), Jeffrey Gundlach, is taking a different course. His fund is 100 percent mortgages, 60 percent in a mix of top-quality, agency backed debt and 40 percent high-quality, non-agency debt, a position, he says, is at an all-time high. “We significantly increased our position in the non-agency portion in March, and much of it we bought at 70 cents on the dollar,” he says. Gundlach adds that better opportunities were to be had in the non-agency market then, and probably now, too. “Both of them, agency backed and non-agency mortgages, will underperform Treasuries in the short-term, but long-term the volatility will provide a lot more opportunities to buy,” he says.

Finally, Gundlach says advisors scared off from mortgages by the noise in the press as the credit bubble deflates would be wise to remember a few things. “Mortgages have high risk-adjusted returns and lower volatility than investment grade corporate debt, junk bonds and Treasuries.”