MORT: A Levered Bet US Rates Have Peaked

seekingalpha2024-06-28

MicroStockHub/E+ via Getty ImagesIntroduction The VanEck Mortgage REIT Income ETF (NYSEARCA:MORT) has materially lagged the SPDR S&P 500 ETF (SPY) so far in 2024, posting a small single-digit decline ...

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I think MORT offers an attractive investment opportunity both if you expect interest rates to stay where they are, but especially if they decline as anticipated by the market. In any case, I think broad market gains (as measured by the SPY) will be muted going forward, with the MORT ETF offering an attractive investment opportunity in a sideways/upward trending market. ETF Overview You can access all relevant MORT information on the VanEck website here. The ETF invests in U.S. mortgage real estate investment trusts, or mREITs, which account for over 99% of fund assets. The portfolio has a tilt to large-cap mREITs which account for 44.85% of ETF assets, followed by mid-cap at 41.34%, and small-cap at 13.39%:   Allocation split by market capitalization (VanEck website (Accessed June 2024))Large Holdings and Concentration You can conveniently download all MORT holdings at this link. Despite having 25 distinct mREIT positions, the ETF is fairly concentrated, with the top ten holdings accounting for ~62.25% of ETF assets:   Issuer Allocation of net assets   Annaly Capital Management (NLY) 11.66%   Agnc Investment (AGNC) 9.08%   Starwood Property Trust (STWD) 7.23%   Rithm Capital (RITM) 6.62%   Blackstone Mortgage Trust (BXMT) 5.14%   Arbor Realty Trust (ABR) 5.10%   Hannon Armstrong Sustainable Infrastructure Capital (HASI) 4.67%   Ladder Capital (LADR) 4.49%   Two Harbors Investment (TWO) 4.14%   Ready Capital (RC) 4.12%   Total top 10 issuers 62.25%   Click to enlarge Source: Author calculations based on MORT daily holdings, June 2024 Given the high cumulative concentration in the top ten positions, you may want to consider investing in the underlying holdings directly, instead of paying the 0.43% expense fee on an annual basis to VanEck for fund management and administration. Risks The main risk facing MORT is the substantial leverage employed by some of its key holdings, as shown in the table below:   Issuer Leverage (Net debt/Market cap)   Annaly Capital Management (NLY) 7.6   Agnc Investment (AGNC) 5.2   Starwood Property Trust (STWD) 3   Rithm Capital (RITM) 5.4   Blackstone Mortgage Trust (BXMT) 5.8   Arbor Realty Trust (ABR) 3.6   Hannon Armstrong Sustainable Infrastructure Capital (HASI) 1.2   Ladder Capital (LADR) 1.7   Two Harbors Investment (TWO) 6.8   Ready Capital (RC) 6.1   Average top 10 issuers 4.6   Weighted average top 10 issuers 4.9   Click to enlarge Source: Author calculations based on MORT daily holdings and Seeking Alpha data. As you can see, a dollar of equity is levered, on average, 4.6 times in the top ten holdings of MORT, or 4.9 times if we take the weighted average. The leverage would be even higher if we account for the preferred shares some of the top ten holdings have issued. This leverage amplifies returns as rates move up and down. As such, a steep increase in interest rates (which isn't my base case expectation) would negatively affect the net asset value, or NAV, of MORT holdings. Likewise, a big decline in interest rates is likely to have a disproportionately large positive impact. The other risk facing MORT is prolonged trouble in the real estate sector, which may negatively affect the repayment of the real estate loans the ETF invests in.  Future Federal Reserve Policy The investment case for MORT rests in the Federal Reserve being at a turning point in its interest rate policy. Current futures prices indicate a 60% chance of a Fed rate easing cycle beginning in September, with the benchmark Fed funds rate seen at about 4.25-4.50% in July of 2025, some 1% below the current target range. Even if the Fed stays put and does not change interest rates, as long as they remain at current levels, MORT holdings will continue to benefit from the leveraged bets on real estate loans which currently carry floating interest rates of between 6.5-8.5%, judging by revolver rates on equity REITs I have covered recently.  Distributions MORT pays quarterly distributions, with the yield currently running in the low double digits on an annual basis, which is quite attractive, although it comes with the leverage caveat already highlighted above. In any case, should interest rates move higher, distributions from the fund's holdings are likely to take a hit. Conclusion Over the past three years, MORT has significantly underperformed SPY, even when we factor in distributions (total returns):   MORT vs SPY, 3-year time frame (Seeking Alpha)In large part, the underperformance has been the result of the Fed rate hiking cycle over 2022 and 2023, which negatively affected bond valuations and underlying real estate. I think we are close to a turning point, with both bonds and real estate becoming more attractive to investors. As a leveraged bet on real estate financing, I think MORT offers an attractive risk-reward buying opportunity, notwithstanding the high underlying leverage employed by its core holdings.  Thank you for reading.","kind":"highlight","is_publish_news":true,"is_publish_highlight":false,"is_publish_live":false,"is_publish_wemedia":null,"editions":null,"column":"","sentiment":"0","news_tag":"","news_rank":0,"symbols":[],"gpt_button":1},"commentList":[],"isCommentEnd":true,"newsSizeData":{"likeSize":0,"commentSize":0,"repostSize":0,"favoriteSize":0,"likeStatus":false,"favoriteStatus":false},"APP":{"userAgent":"Mozilla/5.0 AppleWebKit/537.36 (KHTML, like Gecko; compatible; ClaudeBot/1.0; +claudebot@anthropic.com)","isDev":false,"isTTM":true,"deviceId":"web-server-community-laohu8-v3","version":"4.30.0","shortVersion":"4.30.0","platform":"web","vendor":"web","appName":"ttm","isIOS":false,"isAndroid":false,"isTiger":false,"isTHS":false,"isWeiXin":false,"isWeiXinMini":false,"isWeiBo":false,"isQQ":false,"isBaiduSwan":false,"isBaiduBox":false,"isDingTalk":false,"isToutiao":false,"isOnePlus":false,"isHuaWei":false,"isXiaomi":false,"isXiaomiWebView":false,"isOppo":false,"isVivo":false,"isSamsung":false,"isMobile":false},"href":"/m/news/2446591055"}