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Housing Recovery Will Boost Mortgage Bonds

Friedlander: I believe the floating rate sub-sector of the non-agency mortgage bond market is significantly undervalued. This portion of the asset class underperformed as long-term interest rates declined dramatically since early 2011, driving investors to be "coupon hogs." These floaters have multiple benefits including low interest rate risk and increasing income in a rising rate environment. Additionally, these assets are still trading at a large discount to par and are essentially called back at par via refinancing and other pay downs.

What areas of the market are you presently avoiding?

Friedlander: Currently, we are underweight agency mortgage-backed securities. Sure, the Fed is providing significant technical support, committing to large-scale purchases indefinitely. While this action is positive for the asset class over the near term, once the Fed shifts policy, this temporary support will be gone, lowering overall demand. The problem with Agency MBS arises from increased pay downs, such as refinancing. Since the asset class is trading at a premium, an increase in pay downs lowers investors' realized returns.

Finally, what is your outlook for 2013?

Friedlander: We think that the housing market will continue to improve, pulling the economy along with it. Fed policy will push investors towards non-government guaranteed assets as they search for yield. As money managers begin to look at less traditional fixed income products, we expect to see spreads tighten across the board. However, it is important that we continue to see improving fundamentals driving spreads tighter, not just managers seeking yield, as such is the case in housing. Non-agency bonds offer investors the opportunity to capitalize on these events while taking minimal interest rate risk.

-- Written by Gregg Greenberg in New York.

Disclosure: TheStreet's editorial policy prohibits staff editors and reporters from holding positions in any individual stocks.
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