​Mortgage-Backed Securities Strategy

Article Main Body

Why Invest in Mortgage-Backed Securities (MBS)?

Mortgage-backed securities are one of the largest sectors of the global fixed income market, offering investors a variety of potential benefits, including:

A broad and diverse opportunity set

MBS are backed by U.S. homes and the majority are collateralized by conforming loans and issued by the mortgage Agencies.  The mortgage Agencies, Fannie Mae, Freddie Mac, and Ginnie Mae, are mandated by Congress to assist in the provision of financing in the U.S. housing and mortgage markets.

MBS also have been among the world’s most attractive opportunities for alpha in broader fixed income portfolios due to the fact that trading is usually dominated by accounting and regulatory-constrained investors. These constraints can create attractive opportunities for total return investors. Because of the many potential benefits MBS may offer, financial institutions continue to make substantial allocations to MBS.

Investment Philosophy

Agency MBS have been tremendously liquid, frequently mispriced, and have exhibited robust mean reversion to fair value.

PIMCO’s goal in managing mortgage-backed securities is to generate consistent, long-term outperformance. In our efforts to achieve that goal, we employ a unique approach to the MBS market that emphasizes actively managed exposure to Agency pass-throughs, which we believe offer the greatest potential for risk-adjusted excess returns in a mortgage portfolio.

We believe Agency MBS can offer the best opportunity for excess return in a mortgage portfolio. Our goal in managing MBS portfolios is consistent, repeatable, high-quality alpha.

Investment Process

Security selection is the core of PIMCO’s mortgage investment process. Using our proprietary analytics, we seek securities that offer the highest total return potential for the lowest amount of risk. The MBS markets can become temporarily and sometimes substantially mispriced, but Agency MBS demonstrate robust mean reversion to our proprietary modeled fair value. As a result, we have a value-oriented investment style and tend to be contrarians.

PIMCO does not rely on any single model in its investment process. Rather, we take a multi-faceted approach to MBS valuation, with three major components:

Option-Adjusted Spread (OAS)

Option-adjusted spread is the market standard for analyzing mortgages, but we believe it is weak in isolation and is a poor absolute valuation tool. We use OAS modeling as an important relative valuation tool when comparing securities, but never without supplemental analysis.

Empirical modeling serves as a critical tool designed to systematically exploit market opportunities. PIMCO’s use of empirical modeling derives from the belief that market prices reflect a substantial amount of prepayment information. The extent of prepayment information embedded in market prices combined with the liquidity of MBS make empirical analysis an extremely valuable tool.

Technical Analysis

Analysis of technical factors impacting the MBS market provides critical insights. There are significant clientele effects in MBS trading — as the major MBS investors, such as banks, mortgage servicers and insurance companies are often driven by accounting motives rather than value. As a total return value investor PIMCO seeks to profit from this type of trading. Further, overseas investors continue to be a major source of MBS demand and our close contact with major foreign institutions gives us unique insight into the behavior and preferences of large international buyers and sellers.

We believe using this multi-faceted approach is the most effective and robust method for evaluating the return potential of MBS and the risks they entail.