Today’s market environment is filled with challenges for fixed income investors, from gradually rising interest rates and the reversal of quantitative easing to rich corporate valuations in an extended credit cycle. Mindful of the headwinds potentially facing both Treasuries and corporate credit, agency mortgage-backed securities (MBS) offer an investment option that may help shorten duration and generate alpha with little to no credit risk.
According to Janus Henderson, MBS may offer a welcome diversification option for an investor’s core fixed income portfolio. As investors explore how to move forward with their fixed income allocations, an actively managed MBS ETF might be a good fit. Janus’ recent product addition to this category is the Janus Henderson Mortgage-Backed Securities ETF (ticker JMBS).
The case for agency mortgage-backed securities includes:
Minimal credit risk. Many investors look at MBS funds as risky, especially in the wake of the financial crisis. In fact, many of these funds were not invested in MBS issued by government agencies. These securities carry very little risk of default. The widening in agency mortgage spreads during the financial crisis was largely due to uncertainty as to whether the government would let Fannie and Freddie fail.
They were ultimately placed under conservatorship of the Treasury, confirming the (previously implicit) government guarantee. In order to limit taxpayer liability while under conservatorship, Fannie and Freddie instituted stricter controls on the types of loans they would purchase. Going forward, the comparatively higher quality of Fannie and Freddie securitizations in combination with the government’s backing should serve to mitigate losses during a broader market drawdown.
The portfolio managers are very clear on the point that the portfolio contains no subprime debt securities and invests primarily in agency MBS.
Shorter duration in a rising rate environment. Over the last 10 years, corporate issuers have taken advantage of ultra-low interest rates to extend the duration of investment-grade corporate credit. However, the ability for borrowers to prepay their mortgages prior to maturity results in shorter duration in MBS than most investors realize. Of the major constituents in the Bloomberg Barclay’s U.S. Aggregate Bond Index, MBS has the shortest duration at 5.28 years (source: Bloomberg, as of 9/30/18). As the Federal Reserve continues to normalize interest rates, the intermediate duration of MBS may help reduce the interest rate risk within a portfolio
Why an active ETF?
One challenge with passive ETFs is that they are designed to track, rather than outperform, the index. After fees and expenses, passive MBS ETFs have tended to underperform the Bloomberg Barclays U.S. Mortgage-Backed Securities (MBS) Index. Unlike a stock index, fixed-income indices are effectively impossible to replicate completely.
There are currently no other actively managed ETFs in the agency MBS space that are benchmarked to the Bloomberg Barclays U.S. MBS Index. As the economy moves towards higher interest rates and possibly other pressures, this type of portfolio may become increasingly valuable to fixed income investors.
Active management allows the portfolio managers to identify the agency-backed MBS securities they believe are mispriced in the market and add them to the portfolio. The portfolio can also hold up to 20% of assets in non-agency, which typically includes high quality asset-backed securities (ABS) and commercial mortgage-backed securities (CMBS), and non-agency residential MBS backed by loans to high-credit-quality borrowers.
The fund’s structure lends itself to the transparency inherent in an ETF.
Summary of potential advantages
Janus Henderson’s new JMBS ETF offers a number of potential advantages for fixed income investors that may be worth investigating.
- Invests predominately in high-quality agency MBS assets
- Seeks total returns in excess of the Bloomberg Barclays U.S. MBS Index without taking additional risk
- Offers the potential for broad portfolio diversification benefits with little to no corporate credit risk
- Differentiates itself by employing fundamental loan-level analysis and quantitative modeling in an effort to identify mispriced assets with attractive borrower behavior
- Provides the lower cost, transparency and liquidity characteristics of the ETF structure
This ETF might be a good addition to your client’s fixed income allocation in this volatile fixed income environment.
OBJECTIVE: Janus Henderson Mortgage-Backed Securities ETF (JMBS) seeks a high level of total return consisting of income and capital appreciation.
ETF shares are not individually redeemable and owners of the shares may acquire those shares from the Fund and tender those shares for redemption to the Fund in Creation Units only.
U.S. Treasury securities are direct debt obligations issued by the U.S. Government.
With government bonds, the investor is a creditor of the government. Treasury Bills and U.S. Government Bonds are guaranteed by the full faith and credit of the United States government, are generally considered to be free of credit risk and typically carry lower yields than other securities.
Investing involves risk, including the possible loss of principal and fluctuation of value.
The ETF is new and has less than one year of operating history.
There is no assurance that the investment process will consistently lead to successful investing.
Investors must consider whether any product is appropriate based on that investor’s specific investment objectives, financial situation, time horizon and risk tolerance.
Fixed income securities are subject to interest rate, inflation, credit and default risk. The bond market is volatile. As interest rates rise, bond prices usually fall, and vice versa. The return of principal is not guaranteed, and prices may decline if an issuer fails to make timely payments or its credit strength weakens.
Mortgage-backed securities (MBS) may be more sensitive to interest rate changes. They are subject to extension risk, where borrowers extend the duration of their mortgages as interest rates rise, and prepayment risk, where borrowers pay off their mortgages earlier as interest rates fall. These risks may reduce returns.
Derivatives can be highly volatile and more sensitive to changes in economic or market conditions than other investments. This could result in losses that exceed the original investment and may be magnified by leverage.
Funds that concentrate investments in a single sector will be more susceptible to factors affecting that sector and may be more volatile than less concentrated investments or the market as a whole.
Actively managed portfolios may fail to produce the intended results. No investment strategy can ensure a profit or eliminate the risk of loss.
Diversification neither assures a profit nor eliminates the risk of experiencing investment losses.
Alpha compares risk-adjusted performance relative to an index. Positive alpha means outperformance on a risk-adjusted basis. Correlation measures the degree to which two variables move in relation to each other. A value of 1.0 implies movement in parallel, -1.0 implies movement in opposite directions, and 0.0 implies no relationship.
Bloomberg Barclays U.S. Aggregate Bond Index is a broad-based measure of the investment grade, US dollar-denominated, fixed-rate taxable bond market.
Bloomberg Barclays U.S. Mortgage Backed Securities (MBS) Index tracks the performance of U.S. fixed-rate agency mortgage backed pass-through securities.
An index is unmanaged and not available for direct investment.
Please consider the charges, risks, expenses and investment objectives carefully before investing. For a prospectus or, if available, a summary prospectus containing this and other information, please call Janus Henderson at 800.668.0434 or download the file from janushenderson.com/info. Read it carefully before you invest or send money.
Janus Capital Management LLC is the investment adviser and ALPS Distributors, Inc. is the distributor. ALPS is not affiliated with Janus Henderson or any of its subsidiaries. Janus Henderson is a trademark of Janus Henderson Group plc or one of its subsidiary entities.
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