"They say a little knowledge is dangerous. I've enjoyed reading recent posts touting the inherent value in Mortgage REITS, as if the 15% on offer are some kind of "free lunch". As an investor in mortgage backed securities for 30 years that actually knows some MREIT managers, and a former investor in MREITS, I think its important to recognize that these vehicles (and they are "vehicles", not companies) despite the seductiveness of double digit yields, carry more than average risk.
"Retail investors love to tout the inherent superiority of Annaly Mortgage, as if their managers are alchemists who've found a way to turn lead into gold. Maybe that has worked in a 30yr bull market in bonds, but one only has to look at another bright idea that Annaly foisted on the investing public - Chimera REIT - to see that ain't exactly so. You see, way back in 2008 Annaly thought they could leverage their success in agency MBS by starting a sub-prime MBS "vehicle". With a lot of fanfare they brought CIM to market and started buying sub-prime mortgages. Their timing was not exactly fortuitous. CIM went from $15 to $2. where it is stuck today - a 90% loss.
" It seems whatever skill set Annaly brought to agency mortgages didn't lend itself to related markets. At a minimum, it should cause one to question their judgement especially when one knows these people are former Wall St traders (think Meriwether, Cioffi,Ranieri), not prudent buy side managers like Gross, Gundlach and Fuss.
"Now, its not my desire to trash mortgage REITs, for they have certainly ridden the bond wave. My point is, recognize you are not getting something for nothing. Know that truly gifted MBS money managers like Jeff Gundlach at Doubleline don't try and seduce uniformed investors with double digit yields on their MBS offerings (sym:DBL is one I favor), and think long and hard how and why Annaly and other MREITs do. Know that the shape of the yield curve is incredibly important to the return and NAV of an MREIT. Know that Ben Bernanke's moves to artificially inflate the value of MBS has impacted MREITS. Know that sophisticated SIV managers such as Gordian Knot's Sigma Investments (you can Google them) blew up with a similar strategy. Most importantly, look at the long term chart of 10 year yields that MBS is inextricably linked to, and ask yourself, are we nearer a top in yields, or a bottom? The reason that matters is because MREIT's are leveraged 5:1.
"I humbly submit that the last thing on the planet you want to own at the end of an interest rate cycle is a leveraged investment "vehicle" such as an MREIT. Then again, maybe you'll get out before rates turn, or as Chuck Prince of Citibank famously said, "until the music stops, I'll be dancing!"
David Fuller's view On behalf of the Collective and myself, I am very grateful for this informed email.
One of the less frequently mentioned reasons for why we use price charts is to protect us from what we do not know. Similarly, one of the reasons why we welcome informed views from experienced subscribers is because the Collective will inevitably have far more expertise than Eoin or I could ever hope to amass during a lifetime's fascination with the markets.
This email certainly increases our knowledge of MREITS. We are reminded that super yields and a rising price are achieved with leverage which is always a double-edged sword. I would be very wary of any MREITS which are not trading to the left of a rising 200-day MA, and I would certainly close longs when they accelerate above those same MAs. And when the patterns remain below MAs for more than a brief period, I would assume that the game is over.
In terms of MREITS beyond the short term, we have been warned.