Investors looking for high-quality income, as well as a bargain, should turn to mortgage-backed securities, according to UBS. Leslie Falconio, head of taxable fixed income strategy in UBS Americas' chief investment office, said the bank believes securitized products are relatively cheap compared to investment-grade corporate bonds. They also have current yields of about 5.7%, she told CNBC in an interview on Friday. Agency MBS are government-backed debt obligations issued by agencies such as Fannie Mae, Freddie Mac, and Ginnie Mae. Its cash flows are tied to interest and repayments on a group of mortgage loans. “This is a AAA asset class with pretty much no credit risk and a huge amount of liquidity at a time when we don't expect a hard landing and we expect the economy to slow,” Falconio said. She explained that when the Fed paused rate hikes last fall, and it became clear that interest rates were at their peak, all fixed income performed well. However, she said agency MBS have lagged behind higher-quality peers because they are highly correlated to interest rate fluctuations. “The tailwinds we saw in 2023 that allowed high-yield and investment-grade corporate credit to perform well did not extend to mortgage credit until the beginning of this year,” Falconio said. “It's cheap on a relative value basis.” She specifically likes current coupon mortgages. Investors can play in the space using exchange-traded funds. The iShares MBS ETF (MBB) has a net expense ratio of 0.04% and a 30-day stock yield of 3.54%. The Janus Henderson Mortgage Backed Securities (JMBS) fund touts a 30-day SEC yield of 5.37% and carries a net expense ratio of 0.23%. Although there will be some continued volatility in interest rates in the short term, as the market reacts to different data points, that should decline over the course of the year, she said. Falconio said that with GDP slowly trending downward, the market will become more comfortable with the possibility of the Fed cutting interest rates. It expected that interest rates would fall and that the Mohammed bin Salman program, as a cheaper option, would benefit from inflows. Banks, which invest excess deposits in Treasuries, will be among those turning to agency MBS, Falconio said. Banks will see higher deposits and weaker loan growth as the economy slows, and will turn to MBS to secure higher returns, she said. In addition, the negative impact of the inverted yield curve on agency MBS will reverse this year. UBS believes the yield curve will return to normal and by the end of the year may be slightly upward sloping.
