The world’s biggest bond managers are betting housing debt that rallied as much as 41 percent last year will again beat other fixed-income investments in 2013 as the U.S. real estate recovery strengthens.
TCW Group Inc., Pacific Investment Management Co. and DoubleLine Capital LP are forecasting gains for mortgage bonds without government backing, including those tied to subprime loans, even after hedge funds and other investors piled into the market last year, reducing potential returns.
“Non-agency debt is still the best opportunity in fixed income,” said Stephen Kane, who helps oversee $135 billion at Los Angeles-based TCW. “There is still the potential for significant price appreciation compared with collecting yield on other investments.”
The non-agency market jumped last year as housing started to reverse a six-year slump driven by Federal Reserve efforts to push mortgage rates to record lows. Home values have climbed by more than $1.3 trillion to $23.7 trillion since the end of 2011, according to Zillow Inc., and prices will rise by 3.4 percent in 2013, JPMorgan Chase & Co. analysts estimate.
“The trade has gotten a little bit crowded,” said Daniel Ivascyn, who runs the $21 billion Pimco Income Fund, which returned 22 percent in 2012, beating 99 percent of its peers, according to data compiled by Bloomberg. “You have to be willing to accept price volatility in the near term but over the long run they’re still reasonably attractive.”
Non-agency bonds backed by subprime mortgages issued before the housing market collapsed in 2007 beat most fixed-income assets in 2012, with returns averaging 41 percent, Barclays Plc index data show.
An index tied to bonds created in the second half of 2006 that were issued with AAA ratings rose about 47 percent last year to 50.4 cents on the dollar, according to London-based administrator Markit Group Ltd.
That compares with a gain of about 16 percent for high-yield, high-risk company debt and a 2.6 percent return for mortgage bonds guaranteed by government agencies including Fannie Mae and Freddie Mac, Bank of America Merrill Lynch index data show.
The non-agency debt bounced back from 2011, when it lost 5.5 percent, as Europe’s sovereign debt crisis ignited investor concern that banks would be forced to sell assets and the Federal Reserve Bank of New York botched a plan to auction toxic mortgage bonds it inherited during the bailout of American International Group Inc. in 2008.
The central bank sold the debt last year, fueling confidence that the market for commercial property and mortgage bonds was stabilizing. Goldman Sachs Group Inc., D.E. Shaw & Co. and Angelo Gordon & Co. started pools of capital to invest in housing bonds and hedge funds that invested in mortgages produced the industry’s best returns last year with a gain of about 20 percent.
Kyle Bass, who made $500 million betting against subprime mortgages during the 2007 crash, said in November he was wagering half his firm’s money on a rebound in those assets.
Securities tied to the riskiest mortgages are virtually “bulletproof,” because even if the U.S. housing market declines by 10 percent, investors won’t take a principal hit on their bonds, Bass said in an interview with Bloomberg Television.
While Elliott Management Corp., the $21 billion New York-based hedge fund founded by billionaire investor Paul Singer, expects a “continuation of good news in housing,” it sold residential mortgage-backed securities in the third quarter because their yields had fallen too much, according to a letter sent by the firm to investors.
Analysts at firms including JPMorgan and Credit Suisse Group AG also expect housing to gain next year after prices rose 4.3 percent in the 12 months through October, according to the S&P/Case-Shiller index of 20 cities, the biggest year-over-year advance since May 2010. Sales of previously owned homes jumped 5.9 percent in November from the previous month to reach the most in three years, the National Association of Realtors reported last month.
“The housing recovery is on a firm footing and should continue,” said Kane, who helps run the $24 billion Metropolitan West Total Return Bond Fund, which has beaten 98 percent of comparable funds this year, Bloomberg data show. “The recovery in housing doesn’t need to be heroic for non-agency MBS to deliver double-digit returns.”
TCW estimates high-yield company debt will return about 7 percent and investment grade bonds will gain 3 percent over the next year.
DoubleLine’s Vitaliy Liberman predicts non-agency debt may return up to 8 percent in 2013.
“If we continue to see the trends where the essential economy is chugging along and interest rates are still benign, that’s a very positive environment for housing,” said Liberman, a portfolio manager at the Los Angeles-based firm, which oversees more than $50 billion and is run by Jeffrey Gundlach. “The base case scenario for non-agency securities is very favorable as compared to other fixed income because it’s still trading at a much deeper discount.”