3 Top Mortgage REIT ETFs for Income Investors

Real estate investment trusts that invest in mortgages and mortgage-backed securities, also known as mortgage REITs or mREITs, are favorites among some investors because of their high dividend yields. Yet with the risk involved in mREITs, some investors prefer the diversification that an exchange-traded fund can provide as it spreads the risk across several different real estate investment trusts. For investors seeking exposure to the mREIT space, ETFs like the ones below can provide a convenient investment vehicle.

Data source: Fund providers, ETFdb.com. * Since Nov. 2012 inception. ** Net of fee waiver.

The big player in mortgage REIT ETFs

The iShares line of exchange-traded funds is often the giant in the sectors on which it chooses to focus, and the mortgage REIT universe is no exception. The iShares mortgage REIT ETF is the largest in the space, with a current distribution yield of 9.7% and an SEC yield of 8.7%.

The iShares mREIT ETF is designed to give exposure to the U.S. commercial and residential real estate sectors, with targeted access to a subset of both REITs and domestic real estate stocks. Over time, the ETF has done a good job of matching its target index, the FTSE NAREIT All-Mortgage Capped Index, with returns lagging the benchmark by roughly the amount of the ETF's annual expenses. Mortgage REIT giants Annaly Capital, AGNC Investment, and Starwood Property Trust make up almost 40% of the ETF's assets, with a total of three dozen holdings rounding out the portfolio. With an expense ratio of less than half a percent, the iShares ETF offers its greater trading liquidity without costing a lot more than its peers in the mREIT ETF space.

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Getting some leverage

Mortgage REITs are already highly leveraged, so adding more leverage at the ETF level is a risky proposition. Nevertheless, the ETRACS Monthly Pay 2x Leveraged Mortgage REIT ETN from UBS is designed to magnify the returns from mREITs. Structured as an exchange-traded note, the ETRACS product is a debt security issued by UBS that tracks an underlying index of global mortgage REITs. To qualify, an mREIT must get at least 50% of its revenue from mortgage-related activity, although the index includes both U.S. and non-U.S. mREITs. The ETRACS ETN has a 30-year term that matures in 2042, with the eventual redemption value of the security dependent on how the index performs between now and then.

Returns under the ETRACS ETN are calculated as two times the monthly performance of the index, with the expense ratio incorporated into the return calculation. This creates a correlation and compounding risk, and as ETRACS explains, performance over periods greater than a month is unlikely to be exactly twice the index performance over that longer period. Indeed, some similar leveraged ETFs in other asset classes have seen negative returns even when the underlying index gained in value. However, with a current annualized distribution yield of 17.45% and extremely good returns over its nearly five-year history, ETRACS will be compelling for many mREIT investors.

Another choice for mREIT investors

Finally, the VanEck Vectors Mortgage REIT Income ETF offers a conventional approach to mREIT investing. It seeks to duplicate its MVIS Global Mortgage REIT Index, holding 26 different securities in its portfolio. The VanEck mortgage REIT ETF offers an SEC yield of 9.1%, although its distribution yield is lower than its peers at 6.7%.

The VanEck ETF's holdings are quite similar to those of its iShares rival, with Annaly, AGNC, and Starwood making up a slightly smaller proportion of roughly 30% of the total ETF assets. Thanks to a fee waiver, the VanEck ETF's expense ratio is slightly less than that of the iShares mREIT ETF, although less trading volume can make buying and selling shares of the VanEck ETF somewhat more costly in terms of bid-ask spreads. With a better total return over time than its iShares counterpart, the VanEck ETF is worth a closer look.

Be smart about mREITs

Mortgage REITs can be lucrative income producers, and good ETFs offer exposure to mREITs in a well-diversified package. Each of these three ETFs has advantages and disadvantages, and the right one for you will depend on your particular risk tolerance and investment objectives. If you want high yields, however, it's hard to find ones that will match what individual mREITs have produced over time.