Mortgage Securities Deserve a Bigger Place in Pension Portfolios, DoubleLine Says

Collateralized mortgage obligations (CMOs), which are collections of home-loan bonds, have long been a stalwart of insurers. But for other institutional investors, ownership is scant. DoubleLine Capital, the rising fixed-income power, would like to change that.

And it has some interesting research showing that CMOs dedicated to agency-guaranteed bonds, known as mortgage-backed securities (MBS), can book superior performance over time. MBS, of course, are pools of individual mortgages. Those that agencies support—Fannie Mae, Freddie Mac, and Ginnie Mae, chiefly—carry the pledge that Uncle Sam will cover any defaults.

Once-popular non-government-backed mortgage securities, which took a hit in the 2008 financial crisis, have diminished in volume. These so-called “private label” home-loan bonds dropped by half from then to now, to $1 trillion.

Meanwhile, agency-supported MBS have expanded in importance. Those packaged into CMOs occupy a small but important part of the mortgage securities arena. For the 12 months ending Sept. 30, agency CMOs had a face value of $1.4 trillion (12.4% of the $10.9 trillion MBS universe), according to a study by the Securities Industry and Financial Markets Association (SIFMA).

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The yields on CMOs still tend to be higher than those on comparable Treasury securities, typically the benchmark 10-year note. One big reason is that some homeowners refinance their mortgages, which removes them from the CMO pool. So investors need to be compensated for that risk. Right now, the 10-year T-note yields 1.3%, with the CMO at around 2%. The beauty for agency-supported securities is that Washington ensures that investors won’t lose principal.

“Some people think they don’t get performance” from MBS, said Vitaliy Liberman, a portfolio manager at DoubleLine, specializing in the asset. But they do. “They went to corporate bonds to get alpha, when they could get it from mortgage” securities, too. He credited Jeff Gundlach, the firm’s chief, with the seminal insight that led to this conclusion.

One upside for mortgages as a portfolio holding is diversification. Agency CMOs have a low correlation to corporate bonds. Over five years through Sept. 30, the correlation between corporates and agency CMOs was 0.34 (far afield of 1.0, which is a perfect match), the DoubleLine study showed. That speaks to strong risk reduction involving a good dollop of mortgage instruments.

In addition, during that five-year span, agency CMOs had a slightly higher spread to corporates, the report stated, “with little credit risk and generally lower price volatility.”

During stock market slumps, agency CMOs tend to do better than other types of fixed income. And, classically, bonds offset the stock losses to a degree.

Looking at a longer period to capture this, 1997 through last September, the report gauged that these CMOs (as measured by the ICE BofA Agency Index) outpaced long Treasurys (the Bloomberg Barclays US Long Treasury Index) and long corporates (the Bloomberg Barclays Long Corporate Index). When the S&P 500 lost more than 20%, the CMOs rose 15.4% while corporates managed only 1.4% and Treasurys were up 12.9%.

When the S&P 500’s dip was less severe—down 5% to 10%—Treasurys edged past CMOs, gaining 14.9% to 14.4%, with corporates advancing a still-laggard 9.6%.

Adding agency CMOs to the asset mix would help pension plans a lot, the paper argued. The happy result is that mortgage bonds help a pension program’s funded status. After all, many plans were doing very well up to the 2008 financial crisis, and that carnage set a number of them way back. They’ve been scrambling to regain lost ground ever since.

The study focused on the period from the start of 2005, before things went to hell, to last September. A hypothetical portfolio that was totally into corporates resulted in a funded status of 76%, and one with mortgages securities only was a little better, at 78%.

But put them together, 50-50, and the combo has an even better outcome, 86%. Why? The two “are complementary,” Liberman said. The lower MBS volatility works to produce a higher overall return.

Such alchemy, DoubleLine contended, would be a boon to pension plans far and wide.

CMBS Risk-Retention Deals Gaining More Attention

Tags: 2008 financial crisis, agency, CMOs, DoubleLine Capital, Fannie Mae, Freddie Mac, Ginnie Mae, Jeff Gundlach, MBS, mortgage-backed securities, Pension Plans, S&P 500

Warren Buffett

Warren Buffett’s storied answer to how long he’d hold a stock was “forever.” While that may be true for certain old favorites like Coca-Cola (he’s said to consume five cans of the soda daily), his Berkshire Hathaway conglomerate regularly shuffles its assets.

That remixing tendency is on display in the company’s recent regulatory filing. Berkshire unloaded drug maker Pfizer, miner Barrick Gold, and banking giant JPMorgan Chase. And some of the firm’s ejections are relatively recent additions to the Berkshire lineup.

What’s not clear is why Berkshire has made the recent moves it did. Maybe the upcoming company earnings release and Buffett’s annual shareholder letter on Feb. 28 will bring some clarity.

Buffett watchers have wondered for a while whether such moves are after-the-fact corrections he’s making for earlier purchases by the two investment managers he has deputized to run the portfolio, Ted Weschler and Todd Combs.

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Of course, the shuffling may be strategic course adjustments as Berkshire seeks to find a home for its cash hoard, totaling $145.7 billion as of Sept. 30.

But the reallocations are odd in that some apply to those recent buys. Pfizer and Barrick, for instance, were bought just last year.

The pharma outfit is celebrated as the first to win Food and Drug Administration (FDA) approval for a COVID-19 vaccine. Pfizer stock has a lot of the attributes Buffett looks for, such as an affordable multiple, with a 20 price/earnings (P/E) ratio and a tidy dividend yield of 4.5%.

Compounding the mystery is that Berkshire increased its holdings in three other drug companies: Bristol Myers Squibb, Merck, and AbbVie. Bristol is a latecomer to vaccine development, Merck has given up on its effort, and AbbVie is restricting itself largely to antibody treatments for already infected patients.

Berkshire’s purchase of Barrick shares last year was a real surprise, as Buffett has long been dismissive of gold. Barrick has the virtue of also selling copper, which mostly is an industrial metal. Bullion prices are ahead over the past 12 months, although the yellow metal has slumped since August, and Barrick’s stock price is flat for the period.

Certainly, Buffett has a longstanding affinity for financial stocks. Hence, the exiting of JPM along with PNC Financial appear odd. Berkshire also has trimmed its positions in Wells Fargo and US Bancorp. Last year, Buffett ditched Goldman Sachs.

That said, he hasn’t touched his huge position in Bank of America, Berkshire’s second largest holding, with about a 12% stake in the bank—and it’s a position he has kept for many years. The lowered bank exposure overall may show Buffett’s doubts about continued low interest rates and loan losses due to the virus, according to Doug Kass, president of Seabreeze Capital Investment.

Here’s another puzzler: Berkshire expanded its ownership of Chevron shares. That’s despite its big clean-energy effort; Buffett’s firm has an entire division devoted to solar, wind, hydro, and geothermal power.

Buffett, certainly, has shown through the years that his investing credo must adjust with the times. After long avoiding tech stocks, saying he didn’t understand them, the Oracle of Omaha reversed course. In 2016 and bought $1 billion worth of Apple. Since then, its share price has increased more than fivefold. The iPhone maker remains Berkshire’s largest position, although the company just offloaded 6% of the stock.