Money managers touted the advantages of non-agency mortgage securities and bank loans on Thursday on expectations that housing prices will accelerate and interest rates will rise.
Yields on non-agency mortgages, which are mortgage securities that are not government-guaranteed, are likely to rise at least 5 percentage points as housing prices move higher, investors said at the Morningstar Investment Conference in Chicago.
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"They are a good entry point," said Curtis Mewbourne, managing director and head of portfolio management for PIMCO's New York office. Mewbourne said that yields on non-agency mortgages, which are around 5 percent to 6 percent, could rise an additional 5 percentage points as the U.S. housing market improves.
Last year, non-agency mortgages issued by Wall Street firms prior to the financial crisis were some of the best performing bonds. The bonds rose in part due to a search for yield by investors and a decline in the number of mortgages falling into default.
Mewbourne also said that the selloff in the bond market since May, which has also affected non-agency mortgages, has provided a strong opportunity to invest in the securities.
Bond markets have seen a wide selloff after the Federal Reserve signaled on May 22 that it could reduce its asset purchases this year. The U.S. central bank is buying $85 billion each month in Treasuries and agency mortgage securities in an effort to spur hiring and lower long-term borrowing costs.
The Fed's stimulus has contributed to the rise in housing prices, said Tad Rivelle, chief investment officer of fixed income for TCW. Non-agency mortgages will continue to perform well at current levels, but will also benefit if the Fed maintains its stimulus, Rivelle said.
Rivelle's $9.5 billion TCW Total Return Bond Fund earned a return of 13.37 percent last year, making it the top-performing mortgage-focused fund in the United States, according to Lipper. The fund is up 2.42 percent this year, besting 88 percent of peers.
Rivelle also said that bank loans, which are protected from rising interest rates by being pegged to floating-rate benchmarks, are one of his favorite asset classes in light of his prediction that interest rates will move higher.
Rivelle told Reuters that the recent selloff in bonds could be the start of a new trend of rising interest rates. "This is potentially the early warnings of a significant reversal that you may see in bonds," Rivelle said.
Interest rates will continue to rise over the next 18 months as the Fed moves closer to reducing its asset purchases, said James Keenan, head of leveraged finance portfolios at BlackRock. Keenan told Reuters that the Fed will likely begin reducing its bond-buying in the fourth quarter.
Keenan also said that bank loans will remain attractive in light of rising interest rates on bonds, including a rise in the benchmark 10-year Treasury. The yield on the 10-year Treasury was 2.15 percent at the close of trading on Thursday.
(Editing by Lisa Shumaker)