Tina Adatia, Fixed Income Strategist: Joachim, what’s our view of high quality MBS in the portfolio context?
Joachim Fels, Global Economic Advisor: So, we think agency MBS are a good alternative to generic corporate credit, for example, and there are two reasons for that. One is valuation. The other one is better resiliency in adverse scenarios.
Chart: A triple line chart shows the change in valuations for agency MBS from 2012 to 2019. The model rich/cheap vs. swaps shows 3% rich/cheap vs. 3.5% rich/cheap vs. 4% rich cheap valuations move from near convergence to widening spreads to convergence at the end of the time period.
So, the chart illustrates the valuation point. Actually, we’ve seen quite a spread widening in these products in the course of this year. So, the entry point looks very attractive for us. This is the best valuation we’ve seen in the past ten years. So that’s the first point, valuation. The second point is illustrated in the right-hand chart.
Chart: A bar chart compares average 12-month excess returns vs. like-duration UST for agency MBS and corporates during two different economic environments: expansion and recession. During expansion, corporates performed better than agency MBS, during recession agency MBS outperformed corporates.
It’s the greater resiliency in adverse scenarios. So, what this chart does, it compares the excess return relative to U.S. treasuries for corporate credit in green, and for agency MBS in blue. And you can see during expansions, more excess return in corporates. But then the interesting thing is, when you hit a recession, agency MBS has been very resilient, a small excess return, and you can easily lose in corporate credit. You can easily lose three to four years of outperformance that you made earlier in that recession. So if you think we’re late cycle and bad stuff could happen in the foreseeable future, then this has been the safer part of the broader credit spectrum.
Tina: So good from a downside perspective, but actually attractive valuations today. So, moving on to another part of mortgage credit — what we’re seeing, Andrew, is that buying is cheap.
Chart: Two single side-by-side line graphs compare non-agency MBS fundamentals and technicals. One chart shows the buy-to-rent ration from 2012 to 2019 moving from a position of renting cheaper than buying to buying cheaper than renting. Another chart shows the decrease then increase in home equity from 2008 to 2019.
If you look at the fundamentals in this chart, we show that buying is cheaper than renting. You see that on the left hand chart. We’ve also seen homeowner equity increasing recently. So, what is our view on nonagency mortgages in a portfolio?
Andrew Balls, CIO Global Credit: We continue to see good opportunities here. It’s harder to buy this paper, that’s for sure. But in terms of the holdings we have, you have attractive valuation versus investment grade, or versus high-yield corporate credit, depending on the nature of the non-agency mortgages you have. You have — we think defensiveness, seniority, in the overall capital structure, in the event of a slowdown. We would expect resilience in the event of weaker macro outcomes. And then what is not the most liquid sector, that’s for sure, and it’s hard to buy as much as we would like to buy, given lower production; you don’t have the crowding, we don’t think the technical problems, the liquidity mismatch that we talked about in terms of corporate credit.
There’s other opportunities, UK RMBS we think is quite attractive. There’s Brexit risk premium built into that. There’s some other global opportunities as well, but generally housing-related assets, we think look quite attractive versus corporate credit.
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