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Pimco, Allspring Bet on Mortgage Bonds That Look Cheaper Than Corporate Debt
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Pimco, Allspring Bet on Mortgage Bonds That Look Cheaper Than Corporate Debt
Caleb Mutua and Scott Carpenter
4 min read
(Bloomberg) -- Big bond investors including Pacific Investment Management Co. and Allspring Global Investments are piling into mortgage bonds now, betting that the relatively cheap securities will perform better than comparatively pricey corporate bonds as inflation and tariffs potentially weigh on company profits.
High-grade corporate bond investors aren’t getting paid a lot to take credit risk at the moment. US company bonds pay yields averaging about 0.78 percentage point more than comparable Treasuries as of Thursday, according to Bloomberg index data. That’s close to the lowest risk premium in decades.
Mortgage bonds offer fatter risk premiums. Spreads for Fannie Mae current coupon mortgage bonds, a proxy for securities being created now, were about 1.30 percentage point over a blend of five- and 10-year Treasuries on Friday.
The wider spreads in mortgage bonds may give investors more margin for error. Mortgage bonds will probably perform better regardless of whether tariffs provoke economic risk, Goldman Sachs Group Inc. strategist Lotfi Karoui wrote in a note earlier this month.
“Absolutely remarkable,” Karoui said in an episode of The Credit Edge podcast, referring to agency MBS valuations. “You have an asset class that has zero credit risk and yet it’s paying you 40 to 45 basis points” more than investment-grade bonds.
At the same time, the market may be underestimating how much corporate bonds could get hit by macro and policy changes. Tariffs could raise prices for companies, both directly and indirectly by disrupting supply chains, BofA’s Yuri Seliger wrote in a note last week. A US inflation report last week signaled that prices may be heading higher in general. Both factors can weigh on profits.
Goldman Sachs’s Karoui isn’t the only one singing the virtues of agency MBS. The securities are one of Pimco’s top bets for this year because of their wider spreads and high quality attributes, even as it’s more neutral on corporate bonds.
Allspring, meanwhile, has gradually shifted to an overweight position on agency MBS over the last year from a very large underweight position at the start of 2022, according to Noah Wise, a senior portfolio manager at the firm. The firm has also been cutting back on corporate bond exposure.
An increase in interest-rate volatility as the Federal Reserve started raising rates, coupled with the regional banks crisis in 2023, have caused spreads for MBS to widen to attractive levels.
“The relative value is starting to become even more favorable on the MBS side,” Wise said in an interview. “Not because the valuations are becoming necessarily more attractive in an absolute sense, but compared to other opportunities that we’re seeing in the fixed income space, they’re becoming better value.”
Jason Callan, a senior portfolio manager at Columbia Threadneedle, says he’s also overweight MBS, primarily because of valuations on an absolute basis, adding that tight risk premiums on corporate debt look too thin.
“The spread behavior of corporate credit looks like the markets are very complacent given all of the recent tariff announcements and level of economic uncertainty,” Callan said.
Risk premiums on investment-grade bonds — the extra yield over US Treasuries that investors get paid to hold riskier debt — fell to their lowest levels in more than 25 years after Donald Trump won the US presidential election early November. The exuberance is partly driven by hopes that Trump will cut corporate taxes and reduce regulation, and the fact that investors are pouring money into corporate bonds to lock in attractive yields.
For much of the last two years MBS has largely underperformed investors’ high hopes, repeatedly delivering returns worse than corporate credit amid some of the cheapest valuations for the asset class in years. There simply haven’t been enough investor dollars to fill a gaping hole left behind by the Fed as it unwinds its enormous holdings in the debt.
That may be changing. US banks, traditionally some of the largest investors in agency bonds, are finally expected to return in force to the market this year as the yield curve steepens and deposits rise. They’ve been on the sidelines ever since a rapid increase in interest rates led customers to yank deposits in favor of stashing them in higher-yielding money market funds.
With Trump expected to water down or perhaps entirely scrap the implementation of Basel III Endgame rules, banks might gain additional incentives to invest deposits in securities, including MBS.
Vanguard Group Inc., the world’s second-largest asset manager, is modestly overweight MBS and finds the current spread levels “in the realm of fair value” but not overly cheap, according to Brian Quigley, senior portfolio manager at the firm.
Vanguard also has a favorable outlook for corporate bonds but is running a smaller overweight position than the firm would typically run, partly because of the spreads that are near all-time tights, added Quigley.
For mortgage bonds, even as banks start buying again, Quigley isn’t expecting spreads to tighten back to levels seen post the global-financial crisis when the banks and the Fed dominated the market. But the wider spreads mean the income level is relatively strong.
“We think the sector offers value,” Quigley said. “We think MBS looks attractive compared to Treasuries.”
