Dividend stocks have taken the investing world by storm, as income-starved investors look for ways to make up for rock-bottom yields on bonds and other fixed-income assets. All the new attention on dividend-paying companies has raised awareness of investments that only experts previously knew about.
In large part, you have exchange-traded funds to thank for easier access to dividend-paying stocks. Now, a new ETF focuses squarely on one of the most exciting high-yield opportunities investors can get.
All mortgage REITs, all the time
The brand-new Market Vectors Mortgage REIT Income ETF (NYSE: MORT ) began trading yesterday. It's not the first fund to focus on mortgage REITs -- a rival offering from iShares, iShares FTSE NAREIT Mortgage Plus (NYSE: REM ) , beat the Market Vectors ETF to the punch on that score. But the new arrival does a better job of drilling down precisely on this newly appreciated sector of the REIT market.
What exactly makes mortgage REITs such a lucrative play right now? Your first impression might well be that with the housing market in the dumps, anything with the word "mortgage" in its name would be a risky investment to say the least. But actually, mortgage REITs have benefited from favorable conditions for years, and it now appears that those conditions may persist for years to come.
The business model behind mortgage REITs is deceptively simple. Essentially, the companies borrow money to buy mortgage-backed securities, then use those securities as collateral to get more financing to buy still more securities. The net result is a highly leveraged portfolio that creates massive profits when yield spreads are wide but can also close quickly if the gap between the REIT's borrowing rate and securities income narrows.
Different REITs use different types of securities. Most, including Annaly Capital (NYSE: NLY ) and American Capital Agency (Nasdaq: AGNC ) , focus on government-agency backed mortgage securities. But a few, including Chimera Investment (NYSE: CIM ) and MFA Financial (NYSE: MFA ) , also include non-agency mortgage securities. The difference is that while Fannie Mae or Freddie Mac stand behind the agency debt they issue, non-agency paper doesn't give an REIT as many remedies if the borrower defaults. Rather than going to a government agency to make good on a guarantee, the REIT has to take legal action against a defaulting mortgage borrower to try to recover all or part of its money.
Does an ETF make sense?
The allure of the Market Vectors ETF is that it gives you a wide array of mortgage REITs, with more than 25 in the portfolio. Unlike its iShares predecessor, the Market Vectors ETF does a better job of giving you only mortgage REITs, rather than adding in other loosely related companies like mortgage-originating bank Hudson City Bancorp (Nasdaq: HCBK ) .
Moreover, with so many mortgage REITs offering huge yields, the ETF's overall yield is expected to be a whopping 16%. That beats the yield on the iShares ETF by roughly five percentage points.
From another perspective, though, a mortgage-REIT ETF offers only false diversification. After all, although different mortgage REITs employ somewhat different strategies for selecting assets, they all compete for the same mortgage securities. Moreover, dumping a big group of REITs into a single package doesn't allow you to differentiate between those with high leverage and those with somewhat less leverage. In other words, if you'd rather steer clear of the riskiest mortgage REITs, an ETF takes that choice away from you.
Make the right move
For the convenience of being able to buy several different mortgage REITs in a single wrapper, the 0.40% in annual expenses you'll pay for the Market Vectors ETF is likely money well spent. In the market's hottest dividend sector, as long as the Federal Reserve is willing to give away free money to short-term borrowers, it certainly appears that the huge yields on mortgage REITs could persist through 2012 and beyond.
Believe it or not, mortgage REITs aren't the only good dividend stocks out there. Get some more smart ideas in this free special report from The Motley Fool, which includes 13 dividend-paying stocks that deserve your consideration.