Bonds backed by “Alt-A” mortgages, which were often taken out by borrowers unable to document their income, have gained around 6.3 percent this year, and those backed by subprime home loans have returned about 6.9 percent, according to Bank of America, outpacing junk’s 5.5 percent gain and investment-grade’s 4.8 percent increase. Even bonds backed by relatively safe jumbo loans have risen 5.5 percent.
Gene Tannuzzo, a money manager at Columbia Threadneedle, which oversees $473 billion, said that after those gains, non-agency mortgage bonds still offer better returns given the risk. He’s been buying mortgage-backed securities rated BBB, which can yield 4 percent to 4.5 percent. He’s less attracted to high-yield debt, where average yields have sunk to as low as 5.4 percent this month, far below their five-year average of 6.3 percent, according to Bloomberg Barclays index data.
“A percent or less is not that much of a give-up when you’re talking about going from a speculative-grade asset class to a higher-quality one,” Tannuzzo said.
Investors are betting on housing after years of mortgage credit having been relatively tight. The absolute level of mortgages outstanding has fallen since the crisis, to $8.7 trillion from $9.3 trillion, according to the Federal Reserve Bank of New York. And U.S. home prices have risen an average of 45 percent off their lowest levels, making the collateral for the loans more valuable. Mortgage default rates have been falling since peaking at 5.7 percent in 2009, according to data from S&P Global Ratings and Experian. It hit a post-crisis low of 0.6 percent earlier this year.
In junk bonds, meanwhile, protections for corporate lenders and bond investors have eroded. Junk-rated borrowers tend to have less subordinated debt now, meaning there are fewer other creditors to absorb losses when a company fails. Debt levels have risen relative to assets, which also weighs on how much investors recover if a corporate borrower goes under. With the Federal Reserve scaling down its balance sheet, there will be less demand for riskier assets like junk bonds, Morgan Stanley strategists said in an Aug. 9 note.
Some investors have to hold their noses to convince themselves to buy non-agency mortgage bonds again. “There’s still a level of concern that the past is never quite the past,” said Eric Johnson, chief investment officer of CNO Financial Group, which has $33 billion in assets. Even so, he said he’s been adding mortgage bonds and other structured products, while cutting his exposure to high-yield debt.
That crisis-era taint can help investors, said Ashish Shah, head of fixed income and chief investment officer of global credit at AllianceBernstein, which manages $517 billion.
“I think that’s why there’s good value that remains in that space,” Shah said.
This article was provided by Bloomberg News.