Earlier this week I published a piece on the CFA Institute’s Inside Investing section titled: Mortgage REITs: Does Doubling the Leverage Make Them a Good Investment? The post was my response to UBS launching an ETN that provides 2x leverage on a basket of already heavily levered mortgage REITs “mREITs”.
In short, I believe it’s a dangerous product as many investors in the underlying REITs have little idea how 10%+ yields are being generated. Moreover, they don’t understand the scenarios that could lead to a significant decline in share prices. To paraphrase the great Howard Marks, “…do not confuse adding leverage to an existing investment with increasing return…if you take a 10% return in a security and lever it up 4x and after financing costs generate 15-20% returns, you haven’t increased your returns, you’ve just increased your leverage and significantly increased your risk, but you’ve also got a 20-25% downside threat”. I think this thinking certainly applies to mortgage REITs today.
A bigger threat is upon us
Last week Annaly Capital’s CEO Wellington Denahan-Norris (who this week replaced the late Michael Farrell who tragically passed away), said some very interesting comments to Bloomberg on the state of the risk markets. After discussing the impact of the Fed buying Agency MBS she said:
In short, I believe it’s a dangerous product as many investors in the underlying REITs have little idea how 10%+ yields are being generated. Moreover, they don’t understand the scenarios that could lead to a significant decline in share prices. To paraphrase the great Howard Marks, “…do not confuse adding leverage to an existing investment with increasing return…if you take a 10% return in a security and lever it up 4x and after financing costs generate 15-20% returns, you haven’t increased your returns, you’ve just increased your leverage and significantly increased your risk, but you’ve also got a 20-25% downside threat”. I think this thinking certainly applies to mortgage REITs today.
A bigger threat is upon us
Last week Annaly Capital’s CEO Wellington Denahan-Norris (who this week replaced the late Michael Farrell who tragically passed away), said some very interesting comments to Bloomberg on the state of the risk markets. After discussing the impact of the Fed buying Agency MBS she said:
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