The average MBS yield spread to comparable Treasuries is below the 20-year average of 1.1% but is in-line with the post-recession average [Figure 3]. MBS valuations are average. However, in a range-bound interest rate environment where coupon clipping becomes important, the higher yield offered by MBS may provide a stronger total return opportunity than other high-quality bond sectors, but with less downside risk than credit-sensitive sectors like high-yield.
Traditional valuation metrics are important, but they are only one facet of investing. The scenario analysis outlined earlier helps assess the potential portfolio impacts.
CONCLUSION
MBS are fairly valued but offer the potential for additional yield relative to duration when compared with other high-quality options. In a low-return environment, extra yield is hard to come by, and may have a larger relative impact on portfolio performance than it has in recent years. These factors, along with our belief that MBS may outperform comparable Treasuries if rates stay range bound or rise slightly, make MBS an attractive consideration for suitable investors looking to add high-quality bond exposure to their portfolios.
Anthony Valeri is fixed-income and investment strategist for LPL Financial.