FlexShares, the Chicago-based exchange-traded funds unit of Northern Trust, expanded its product line-up with the recent launch of the passively-managed FlexShares Disciplined Duration MBS Index Fund (MBSD). Though FlexShares has a wide array of products in the traditional equity and fixed-income segments, MBSD is the first mortgage-backed securities product from the company.
The new fund tracks the BofA Merrill Lynch Constrained Duration US Mortgage Backed Securities Index, a gauge designed to measure the performance of 30-year, 20-year and 15-year fixed rate residential mortgage pass-through securities publicly issued by US government agencies, including Fannie Mae, Freddie Mac and Ginnie Mae.
Index constituents must have at least one year to maturity and meet the size requirements. Mortgage pass-through securities are backed by a pool of mortgages and the prepayment-risk is distributed across all the loans in the portfolio.
MBSD uses a disciplined duration approach, which means it seeks to limit the effective-duration extension and contraction variability (i.e. lower volatility) caused by market factors, including prepayment assumptions.
The portfolio consists of 57 securities with ratings varying between AA+ (S&P), Aaa (Moody’s) and AAA (Fitch). MBSD targets an average effective-duration of 3.75 years while the permissible range varies between 3.25 and 4.25 years. The portfolio has a weighted-average coupon of 4.5 percent while weighted average yield-to-maturity comes at 1.98 percent.
The new fund is likely to face stiff competition from iShares MBS ETF (MBB) and the Vanguard Mortgage-Backed Securities Index ETF (VMBS). However, income investors who wish to access the MBS sector and are seeking exposure in superior credit quality and higher yields may consider the FlexShares fund as it has lower price volatility, which typically are caused by varying duration in a changing interest-rate environment.
The housing market is witnessing greater activity on the back of an improving job market. The Fed’s assurance of low interest rates for “an extended period of time” is likely to add further impetus to the housing market going forward. That makes the MBS segment an attractive option.
MBSD has an annual net expense ratio of 0.2 percent.
Disclosure: No holdings