Mortgage Backed Securities as Part of Bond Allocation?

[mukramesh]

I'm not totally following the advantage of this. Does adding MBS somehow increase the expected return or lower the volatility of the portfolio?

Are MBS priced like treasuries? (I.e. price goes up as interest rate goes down and vice versa).

My understanding is MBS are low yield (but probably higher than corresponding treasuries) and have a non-zero chance of default.

[vnatale]

https://investor.vanguard.com/etf/profile/VMBS

VMBS = vanguard etf

“ Invests primarily in U.S. agency mortgage-backed pass-through securities issued by Ginnie Mae (GNMA), Fannie Mae (FNMA), and Freddie Mac (FHLMC).‘

Those are at least one level away from being Treasury Bills. They were backed during the Financial Crisis of 2008 / 2009 but no guarantees they will so during the next financial crisis.

[D1984]

https://investor.vanguard.com/etf/profile/VMBS

VMBS = vanguard etf

“ Invests primarily in U.S. agency mortgage-backed pass-through securities issued by Ginnie Mae (GNMA), Fannie Mae (FNMA), and Freddie Mac (FHLMC).‘

Why not invest in VFIIX/VFIJX instead of VMBS? The former contains (IIRC) only pure agency paper (i.e. nothing from Fannie Mae or Freddie Mac but rather only explicitly Federally guaranteed MBS paper such as that securitized from FHA and VA mortgages) rather than having a mix of FNMA/FHLMC/GNMA stuff like VMBS has.

If you go to PV and compare VFIIX to VFITX you will see that it has a higher Sharpe and a smoother total return curve than VFITX has. VFIIX does maintain a slightly lower duration and maturity than VFITX so it (not surprisingly since we've been in a period of falling rates for the last 40 years) trails VFITX a tiny bit in CAGR.

Roger Ibbotson did a study back in the early 80s comparing long Treasury securities, intermediate Treasury securities, intermediate agency (pure agency MBS and other 100% Federally-guaranteed agency paper, not FNMAs) securities, long-term corporate bonds, US large stocks, US small stocks, foreign stocks, and commodities since the late 40s or early 50s; it has annual year to year returns for each asset class. I have a PDF'd copy of it somewhere; I'll see if I can find it so we can have a good data set for Agency security returns (i.e. a suitable proxy for VFIIX) back during a time of rising rates and see how it might've fared against a hypothetical VFITX during this time period.

[jreality]

That chart was from the end of 2009 going into 2010 when the economy was starting to recover. I can't find any data on VMBS prior to the end of 2009.

BTW I've seen charts of VFIIX where it it did gradually declined almost 9% over a couple years, from Aug 2011 to Sept 2013 (although I don't know what the distributions were at the time). So, depending on upon what the distributions were at the time, it may not have declined in total return by almost 9% but the price per share of the fund did.

Certainly VMBS and VFIIX can easily incur 5% of drawdown in a crisis.

J.

Here's what VMBS did during the 2009 melt down:

e74a4c972882.jpg

At first glance that chart looks horrific. And when you look at the axis titles, it shows that for a 3 week period, the fund lost about 0.5% and then nearly fully recovered by the end of the 3 week period. Possibly fully recovered except for an end of year dividend.