MBS Fund Columbia Has Made Lemonade out of Lemons
The very thought of investing in non-agency mortgage backed securities still strikes fear in the hearts of many investors. The ones that collapsed are still very much alive though.
Mortgage backed securities, or MBS, became a household name during the housing collapse of 2007-2008, and the crash of these securities became blamed for a serious financial crisis that took us quite a while and a lot of money to get ourselves out of.
There are actually two types of mortgage backed securities, ones that are guaranteed by the government, called agency MBS, and ones without the backing of a government agency, called non-agency MBS. Non-agency mortgage backed securities are generally composed of mortgages that are not a high enough quality to be agency mortgages, so they are both of a poorer quality and not guaranteed.
Some may wonder what ever happened to these non-agency mortgage backed securities that collapsed in 2008, and the answer is that they did not just disappear and are still around over a decade later. We’re not talking about new issues here, as there have not been any of this particular type issued since, we’re talking about the same ones that got crushed back then.
A lot of the mortgages that were included in these securities are still amortized though and therefore the securities did retain some value after the collapse. A lot of the mortgages did default, but with the ones that did not, this debt needs to be owned by someone, and they have been traded since.
With both a better understanding of the risks and a desire for value, mortgage funds swooped down and picked up these assets very cheaply. That actually turned out to be a good move as the economy stabilized and we returned more to normalcy, back to a time where this sort of asset was actually seen as desirable. They still are, provided the right amount of attention to risk is used with them, as is the case now.
Even the Worst Securities Can Be Priced Low Enough to Be Attractive
No one thinks that these are AAA securities anymore, or anything close to it, but when you get to buy them cheaply, this increases the yields on them much like buying bonds lower does. These securities do pay out fixed income streams from the proceeds of the mortgage payments they collect, and as long as we calculate the added risk in, you can shoot for a risk-return ratio that is quite appealing.
As is usually the case, the real time to get involved in such a thing is at the ground floor, when prices are so beat down and the upside is much higher than the downside. Forward-looking mortgage funds did step in at this time, even though the streets were filled with blood, and this is often the best time to get back in the game actually.
The Columbia Mortgage Opportunity Fund was one of these funds who seized the opportunity, and this was an opportunity that doesn’t come along every day and may not come around again. We needed a debacle with these securities of the magnitude that we did see for this to work out so well, and while their original yields were paltry and on par with high grade bonds, when the price dropped so much, things really changed.
Columbia is more of a niche mortgage fund, as mortgage funds generally haven’t had the stomach to have a large part of their portfolio in sub-prime debt, but even the big ones have managed to sprinkle some in in spite of focusing mostly on less risky securities.
Non-agency MBS once had a market capitalization of $2.5 trillion, before the meltdown that is, and still hold about $600 billion in assets. The new class of mortgage backed securities that have taken their place, the more appropriately named non-qualified mortgage backed securities, has only been able to grow to $12 billion thus far, so the real money is still in the old MBS of yesteryear.
Most of the mortgages in this $600 billion basket of old MBS will mature in the next 5 years, so it’s not as if this is something that investors can seek to capitalize on forever. Columbia also takes great pains to manage their risk, balancing their positions in these riskier securities with more solid ones such as agency MBS.
They have been gradually moving away from non-agency MBS toward agency backed mortgage securities, and at present, non-agency MBS only comprises 29% of their $1.2 billion of assets under management, with 46% now in agency MBS. Just 5 months ago, the count was 46% non-agency and 26% agency, which gives us a view of how much they have shifted.
This trend is expected to continue, perhaps not at the same rate, as the approach overall is more on the conservative side than we would think that a fund that is engaged with such an infamous asset would be.
Columbia Has Navigated This More Treacherous Terrain Very Well
In terms of performance, the Columbia Mortgage Opportunity fund has averaged a return of 7.1% over the past 3 years and is in the top 10% of non-traditional bond funds. While this may pale compared to what stocks have done, Columbia has achieved this while managing risk, as bond funds need to do, and the fund was actually up during last year’s fourth quarter stock market hit that saw it give up almost 20%.
The fund has also been dabbling in non-secured debt as well, with the same degree of care that it has used with its MBS investments. It has also taken on a significant position in commercial mortgage backed securities, which generally involve only a single property and are therefore a lot easier to manage and predict.
Lead portfolio manager Jason Callan came to Columbia just around the time of the collapse as a non-agency MBS analyst. Two years later, after the dust settled, he was put in charge of the company’s structured products, including the Mortgage Opportunity Fund.
He started moving more of the fund’s assets into AAA bonds last year, when he sensed a slowdown in growth in the economy. This decision has proved to be key with enhancing the returns of the fund as well as managing current risk.
Callan sees mortgage backed securities today as relatively safe, even though the non-agency ones are obviously higher risk. We at least appreciate the risk involved much better than back when he started, and he appreciates the new credit enhancements and additional transparency built into the new non-qualified mortgage backed securities that are replacing the old non-agency ones as they move towards expiration.
The biggest improvement though is our segregating this below prime and non-guaranteed secured debt within its own class instead of mixing asset grades like we did before the collapse. It’s perfectly fine to package even the riskiest assets together as long as the risk is known. It was not back then, but it surely is now. Even people on the street now realize that these are higher risk investments, but may over-estimate the risk, relying on memories of the past. With a good understanding and sound management practices, even junk securities like this can serve to be a benefit to investors.
If you are looking to invest in debt that may contain mortgage backed securities, fund selection is even more important than with your usual bond fund. This is not something you want to do yourself, but in the right hands, this can be made safe enough. Columbia’s product certainly stands out as among the very best in this category of funds, and seems well-positioned to continue this as we move away from these expiring securities and look to continue to seek to capitalize on the sub-prime market.
Editor, MarketReview.com
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