MBB: An Unlevered RMBS Vehicle Acting As A Sovereign Diversifier

An analysis suggests the iShares MBS ETF (MBB), which invests in secondary agency RMBS, could serve as a diversifier for U.S. Treasuries due to its underlying guarantors having similar credit ratings to the U.S., and lower standard deviation and max drawdown ratios compared to the intermediate-term treasury vehicle IEF ETF; however, risks include price swings, prepayment risk, and reinvestment risk.

Analysis

Amid observations of potentially diminishing investor confidence in U.S. Treasuries and municipal debt, the iShares MBS ETF (MBB) is presented as a viable sovereign diversifier. This vehicle, which invests in secondary agency Residential Mortgage-Backed Securities (RMBS), benefits from underlying guarantors possessing credit ratings equivalent to the U.S. government; furthermore, these RMBS are deemed credible enough to function as collateral for repo lenders. From a risk perspective, the MBB ETF exhibits a lower standard deviation and a smaller maximum drawdown when benchmarked against the iShares 7-10 Year Treasury Bond ETF (IEF), an intermediate-term U.S. Treasury vehicle. The outlook for MBB includes a potential 'positive duration effect' kicking in towards late 2025, and an anticipated lag in reinvestment rates that could sustain distribution levels for several quarters. Identified risks associated with MBB include susceptibility to occasional abrupt price swings, prepayment risk in the event of a sharp decline in interest rates, and general reinvestment risk. The overall sentiment surrounding this analysis is moderately positive, with a particularly strong positive sentiment for MBB (0.75) versus a slightly negative sentiment for IEF (-0.25), underscoring MBB's potential as an alternative or complement to traditional treasury holdings.

Key Decisions for Investors

• Investors seeking to diversify their fixed-income allocation away from direct U.S. Treasury exposure, particularly given concerns about prevailing market sentiment, may find the iShares MBS ETF (MBB) a suitable alternative, given its comparable credit quality and distinct underlying assets.
• Consider MBB's historically lower volatility metrics, such as its reduced standard deviation and maximum drawdown compared to the IEF ETF, which could be attractive for capital preservation strategies or for enhancing risk-adjusted returns within a bond portfolio.
• Actively monitor interest rate movements due to MBB's exposure to prepayment risk if rates fall sharply, and also track reinvestment rate trends and the projected positive duration effect in late 2025, while being prepared for potential occasional abrupt price swings.