Long/Short Investments
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Long/Short Investments in L/S Equity: Valuation and Ideas,

Mortgage REITs In A Portfolio?

Mortgage REITs (sometimes simply referred to as “mREITs”) are fundamentally a business that invests in mortgage loans and/or mortgage-backed securities with the hope of generating a return primarily from the interest. This follows the standard “borrow short, lend long” model wherein a steeper yield curve is more favorable than a flatter or inverted curve.

Hence, it’s very much the type of company whose prospects follow the business cycle, at least more so than something inherently less cyclical (e.g., consumer staples) or business contingent on a different type of cycle (e.g., oil or commodity-related). Normally these are best to buy coming out of recession rather than as we enter the late stage of the business cycle as we’re going into now with central banks looking to rein in liquidity.

They are nonetheless popular among many investors due to their high dividend yields. REITs are subject to business regulations that require them to pay out at least 90% of their earnings to shareholders in exchange for favorable tax treatment.

Mortgage REITs generally utilize a notable degree of leverage in their portfolios, which leads to above-average volatility. For example, Annaly Capital Management (NLY), one of the most prominent mREITs, has generated 1.5x the volatility of the S&P 500 since it went public in 1997.

For those that would rather go with an ETF, such as MORT, the exposure to thousands of different mortgages provides the advantage of a natural hedge. This particular ETF puts 64% of its weight into the top 10 assets and contains just 25 assets overall. It contains the following:

One can expect MORT to be about 15%-20% more volatile than the S&P 500 and will provide 50%-55% correlation, which is relatively low given both are comprised of common stock.

Overall, MORT can be a reasonable addition for those making a bullish bet on the US real estate market or even as a long-term play for those wanting to diversify their portfolio with an income-generating component with mild correlation to the broader market.