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1 mREIT's Surprising and Risky New Strategy

Gary Kain and team went on a surprising shopping spree.

In an interesting development, American Capital Agency (NASDAQ: AGNC  ) added a new line item to its balance sheet: "REIT equity securities."

Yes, American Capital Agency is buying other mREITs. Which mREITs? We don't know -- neither the conference call nor the press release contain any identifying information.

American Capital Agency CIO Gary Kain did say the total portfolio was approximately $400 million, roughly 50% higher than the $267 million balance reported as of December 31, 2013.

The takeaway: American Capital Agency is doubling down on mREITs, and we can assume it only bought more when the sector struck a low point in January.

What's the deal?
Analysts were quick to ask about American Capital Agency's purchases of other mREITs. How could they get comfortable with other managers' mortgage picks? How big would this investment strategy become? And how would American Capital Agency weigh buying back its own shares against the shares of other mREITs?

There were few direct answers. Kain did say American Capital Agency did have "capacity to do a meaningful amount more of this," but investors shouldn't think of it as something that will become 20% of the portfolio. By all indications, it'll stay a small part of the portfolio.

There are plenty of reasons to take issue with a company buying shares of other companies in its industry. First, buying stock of other mREITs has the effect of leveraging the portfolio. Second, American Capital Agency doesn't have a day-to-day bird's-eye view of rivals' positions. It has to wait for quarterly filings, just like individual investors, inserting new risks.

Finally, there's the potential another mREIT takes a completely different view of the mortgage market than American Capital Agency, and that buying shares in other mREITs may undo some of the strategies American Capital Agency deploys.

As for potential targets for American Capital Agency, we can surmise it was buying other companies that traded at lower book value multiples than itself. Companies like CYS Investments (NYSE: CYS  ) , a pure play on agency mREITs, traded at a 20% discount to book value. Annaly Capital Management (NYSE: NLY  ) may have also made the shortlist, being a mostly agency mREIT that has traded in the same price-to-book value band as American Capital Agency.

The real takeaway
The fact that American Capital Agency is buying other mREITs leads me to believe Kain agrees with a growing group of mREIT investors that the best time to buy an mREIT is when you can get shares at a big discount to book value.

Though you can't know what an mREIT is worth at any time between quarterly filings -- and even that data is dated -- you do get favorable odds when shares sell for less than the liquidation value of the portfolio. American Capital Agency shareholders won't get a choice, however. It seems like this will be a strategic component of the portfolio for some time to come. 

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