Keeping House

Mutual funds made up of mortgage-backed securities were once a reliable, relatively stable way of picking up a little extra yield over and above Treasury securities and corporate bonds, depending on the quality. That was before 2007 and early 2008, when roughly $1.4 trillion in subprime and other lower quality mortgages nearly crashed the world financial system, bringing on arguably the worst recession since the Great Depression in the 1930s.

For whatever reasons, investors have been drawing billions of dollars of their money out of mortgage-backed mutual funds, with more than $24 billion withdrawn from January 2005 through 2008. (That’s according to the Investment Company Institute, the mutual fund industry’s trade organization.) You’d think that things would have been disastrous for any MBS mutual fund investor who toughed it out through ’08 and ’09.

Not so. Why? Three words: the Federal Reserve. Beginning in December 2008, the Fed began making massive purchases of mortgage-backed securities, pumping more than $19 billion into the MBS mutual fund market. The result: surprisingly good returns for investors.

But now the Fed is signaling a pullback, and an eventual halt, to those purchases. What does that mean for investors? We checked in with Todd White, a vice president and senior sector team leader for fixed income investments at RiverSource Investments, the money management arm of Ameriprise Financial in Minneapolis. He manages roughly $24.5 billion in these types of securities.

When we last looked at these funds a little over a year ago, the market was falling apart and the spreads—the risk premium investors were paying for the funds—were going through the roof. That means that their value was dropping dramatically. What has happened since that time?

The spreads on mortgage-backed securities widened significantly in 2008 after Lehmann collapsed and before the government not only took rates to zero but put in place the quantitative easing measures. In the fall of 2008, MBS mutual funds substantially underperformed, but the agency mortgages—those implicitly guaranteed by the government—never got as battered as the non-agency sectors, which would be prime securitizations, Alt-A, and subprime.

Then the government announced the program to basically purchase agency mortgages, agency debt, and Treasuries, so they have been supporting the market since the beginning of last year.