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Summary Despite their high yields, MORL and MORT have recorded negative total return performances in 2015. Surprisingly, the top 7 holdings of the fund all posted better YTD returns than the index. A number of smaller mREITs have fallen > 20% this year and may offer attractive entry points for the aggressive investor. Investors in the Market Vectors Mortgage REIT Income ETF (NYSEARCA: MORT ) and the 2x leveraged version, the UBS ETRACS 2x Leveraged Mortgage REIT ETN (NYSEARCA: MORL ), have not had a good year so far. Despite a recent rally triggered by the Fed’s decision not to raise interest rates, MORT is still down by -5.39% year-to-date [YTD], while MORL is down -12.5%. The iShares Mortgage Real Estate Capped (NYSEARCA: REM ), an ETF that tracks a different index than MORT/MORL, has performed slightly better at -4.00% for the year. MORL Total Return Price data by YCharts As an investor in MORL, I wanted to find out why the fund was doing so poorly. I first checked the YTD performance of Annaly Capital (NYSE: NLY ) and American Capital Agency (NASDAQ: AGNC ), the two largest constituents of MORT/MORL that together constitute nearly 25% of the index. However, neither stock has done as poorly as MORT. NLY has eked out a positive return of 1.89% in 2015, while AGNC is down by -3.41%. NLY Total Return Price data by YCharts I then checked the performance of the five next-largest constituents of MORT/MORL. Surprisingly, these five stocks have also all outperformed MORT. New Residential Investment Corp (NYSE: NRZ ) leads the pack with a YTD total return performance of +19.46%. STWD Total Return Price data by YCharts Summarizing the observations so far, the seven-largest holdings of MORL/MORT, which account for over half of the fund, have all outperformed the index. This suggests that the remaining constituents of the index have underperformed. To investigate this further, I obtained the weightings and YTD performance data of the 24 constituents of MORT/MORL from Morningstar . Note that the total return data may differ slightly from the YCharts graphs above. For the rest of the article, the Morningstar data will be used. Company Ticker % Assets YTD return / % Annaly Capital Management Inc NLY 14.70% 1.94% American Capital Agency Corp AGNC 10.21% -3.23% Starwood Property Trust Inc STWD 6.20% -2.28% New Residential Investment Corp NRZ 5.40% 22.32% Chimera Investment Corp CIM 5.37% -3.58% Two Harbors Investment Corp TWO 5.24% -0.10% Blackstone Mortgage Trust Inc BXMT 5.22% 3.47% Mfa Financial Inc MFA 4.42% -5.26% Hatteras Financial Corp HTS 4.36% -6.78% Colony Financial Inc CLNY 4.33% -5.00% Invesco Mortgage Capital Inc IVR 4.22% -6.14% Cypress Sharpridge Investments Inc CYS 3.95% -3.90% Pennymac Mortgage Investment Trust PMT 3.75% -17.88% Capstead Mortgage Corp CMO 3.12% -9.93% Apollo Commercial Real Estate Finance I ARI 3.02% 7.70% Armour Residential Reit Inc ARR 2.83% -21.81% American Capital Mortgage Investment MTGE 2.58% -6.61% New York Mortgage Trust Inc NYMT 2.58% -12.05% Redwood Trust Inc RWT 2.24% -20.96% Anworth Mortgage Asset Corp ANH 1.57% 2.86% Resource Capital Corp RSO 1.46% -27.83% Rait Financial Trust RAS 1.26% -22.82% Dynex Capital Inc DX 1.15% -14.79% Newcastle Investment Corp NCT 0.98% 13.59% The results above confirm my initial suspicion. While the top 7 holdings in the index (together accounting for over 52% of assets) had an average YTD performance of +2.65%, the remaining 17 constituents had an average performance of -9.27%. The data above is also shown in graphical form. There is weak positive correlation between % assets and % YTD return, indicating that the largest mREITs have outperformed the smaller mREITs so far this year. (The index uses a cap-weighted methodology, meaning that mREITs with a greater weighting in the index have larger market caps). The data is also shown in bar chart form below. We can see that most of the worst-performing mREITs lie on the right hand side of the chart, i.e. the big losers have all been smaller-cap mREITs. A notable exception is NCT, which is the smallest holding in the index but recorded a +13.59% YTD gain. Implications for investors What does this mean for mREIT investors? Firstly, we can see that there is a very wide dispersion in YTD return performances. NRZ has the best total return performance of +22.32%, while RSO has had the worst total return performance of -27.83%. However, past performance is no guarantee of future results, and investors uncomfortable with picking individual mREIT names may still prefer to remain diversified by investing in MORT/MORL. MORT has a trailing 12-months [TTM] yield of 11.07% and MORL has a TTM yield of 29.23%. Secondly, it is unclear whether the outperformance of large-cap mREITs vs. their small-cap brethren will persist into the future. The constant jitters and palpitations over a potential rate hike in 2015 may have unfairly punished small-cap mREITs, which are probably deemed to be more risky and volatile compared to their larger peers. However, this is just my rough guess, and more knowledgeable mREIT investors may have a better answer to this conundrum. A full analysis of the effect of interest rates on the performance of each mREIT is beyond the scope of this article. Finally, I hope that investors who are comfortable with selecting individual mREITs may still find the data useful. With further potential interest rate turmoil ahead, does one stick with the industry bellwethers NLY and AGNC which have weathered the storm so far in 2015? Or does one go bottom fishing with small-cap mREITs such as ARR, RWT, RSO and RAS that have all fallen more than 20% YTD, with the hopes of a rebound? The answer will depend on each investor’s risk appetite and interest rate outlook. Disclosure: I am/we are long MORL. (More…) I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article. Scalper1 News
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