Home on the Exchange

With the housing market imploding, and no end to the drop yet in sight, this doesn't seem to be the best time to launch a mortgage-backed ETF. Nonetheless, BGI's iShares Lehman MBS Fixed-Rate Bond Fund (AMEX: MBB) came to market in the middle of March. This is the first exchange-traded fund to provide exposure to mortgage-backed securities, and it can provide diversification benefits to investors' portfolios. Because the fund can be sold short, it can be used to take advantage of both positive and negative changes in the mortgage market.

The fund tracks the Lehman Brothers U.S. MBS Fixed-Rate Index, which is made up of investment-grade agency mortgage-backed securities. Mortgage-backed securities are bonds that represent a claim on the principal and interest from mortgage loans. Most mortgages are no longer held by banks but are bundled together so that they can be sold as securities in the market. Mortgage-backed securities tend to pay out a higher yield than government or corporate bonds of comparable quality.

We three
The bond fund has roughly $20 million in assets and has spread its investments over 15 triple-A rated securities from Fannie Mae, making up 51% of the total; Freddie Mac, 39%; and Ginnie Mae, 10%. The bonds have a weighted average coupon of 5.54% and a yield to maturity of 5.62%, which gives investors looking for yield a pretty good idea of what to expect, at least for the immediate future.

Yield with diversification
The fund offers exposure to fixed income. In addition, it's likely to have a slightly higher yield than that found with treasuries or corporate bonds because of the risk that mortgages may be paid off early. The fund is fairly conservative and doesn't have investments in the subprime market.

The long and the short
Investors looking to short this fund will want interest rates to rise. Higher interest rates can cause the value of mortgage-backed securities to fall as homeowners pay off their mortgages at a slower pace. Long investors, on the other hand, want rates to stay steady or fall, to boost bond prices, but not so much that investors pay off their mortgages and reduce the high interest payments.

For investors who want to incorporate mortgage-backed securities into their portfolio, the iShares Lehman MBS Fixed-Rate Bond Fund is an easy and relatively inexpensive option, with an expense ratio of 0.25%. There are now more than a dozen fixed-income ETFs from which to choose to fill out a fixed-income allocation, and with an uncertain real estate market this might be a fund for another day. My personal preference would be to wait on this fund, at least on a long position, until the real estate market settles out some more.

Need new ideas for your money? Talk stocks and mutual funds with other investors and our analysts when you give our newsletters a try.

Fool contributor Zoe Van Schyndel lives in Miami and enjoys the sunshine and variety of the Magic City. She does not own any of the funds mentioned in this article. The Motley Fool has a disclosure policy.