MacroVoices #449 Harley Bassman: The Magic of Mortgages
Harley Bassman argues that mortgage-backed securities (MBS) are currently the best risk-adjusted investment in the bond market, particularly newly issued higher-coupon bonds trading near par. He believes the bond market has found its trading range around current levels and sees MBS as an attractive way to sell volatility through embedded call options.
Summary
Harley Bassman, convexity maven at Simplify Asset Management, presents a compelling case for mortgage-backed securities as the optimal bond investment in the current environment. He explains that MBS represent the second largest asset class in the bond market after Treasuries, yet retail investors rarely trade them directly due to their complexity involving monthly principal repayments, reinvestment risk, and tax complications. Instead, they access MBS through ETFs and mutual funds. Bassman's core thesis centers on the embedded optionality in mortgage bonds - when purchasing MBS, investors are essentially doing a buy-write strategy, selling call options to borrowers who can refinance. The recent inverted yield curve and high interest rate volatility have made these embedded options extremely valuable, causing mortgage spreads to widen from the historical 75 basis points over Treasuries to 125-170 basis points. He argues this presents an exceptional opportunity, particularly in newly issued mortgage bonds with 5-5.5% coupons trading near par, rather than the legacy low-coupon bonds that dominate mortgage indices. Bassman believes bonds have found their range, with the 10-year likely trading between 3.5-4.5% as the Fed targets a 2.5% funds rate in a world of persistent inflation driven by boomer retirements and millennial household formation. His strategy involves actively managing a portfolio of current-coupon mortgage bonds, keeping them between 97-101 price levels to maximize the value of embedded optionality. He launched an ETF (MTBA) to implement this strategy, made possible by recent SEC rule changes allowing derivatives in ETFs. Bassman dismisses credit concerns about agency MBS, noting they require high FICO scores and have government backing, making default risk negligible.
About this episode
MacroVoices Erik Townsend & Patrick Ceresna welcome back, Harley Bassman. They will discuss mortgage backed securities and the best way to trade them. https://bit.ly/4ezISv9 ⚫ Follow Harley Bassman on X: https://www.x.com/ConvexityMaven🔻Download Big Picture Trading Chartbook: 📈📉: https://bit.ly/4dARobW ✅Sign up for a FREE 14-day trial at Big Picture Trading: https://bit.ly/3WbYmgH 🔴 Subscribe to Patrick’s Youtube Channel: https://www.youtube.com/@Patrick_Ceresna 🔴 Subscribe to Erik's Substack: https://eriktownsend.substack.com/ 🔴 Check out Energy Transition Crisis on YouTube: https://www.youtube.com/@EnergyTransitionCrisis1 Please visit our website https://www.macrovoices.com to register your free account to gain access to supporting materials
Key Insights
- Bassman argues that mortgage-backed securities are currently the best risk-adjusted investment in the bond market, trading at 125 basis points over Treasuries compared to investment grade credit at only 53 basis points
- He contends that newly issued mortgage bonds with 5-5.5% coupons are superior to legacy low-coupon bonds in mortgage indices because they offer larger embedded option premiums
- Bassman claims the inverted yield curve has artificially inflated the value of embedded call options in mortgage bonds, creating a pricing distortion that benefits buyers
- He believes the bond market has found its range with 10-year yields likely staying between 3.5-4.5% as economic fundamentals normalize around Fed targets
- Bassman argues that demographic trends - boomer retirements reducing labor supply and delayed millennial household formation creating demand surges - will keep inflation persistently above the Fed's 2% target
- He dismisses credit risk concerns about agency mortgage-backed securities, noting they require FICO scores above 720 and have effective government guarantees through Fannie, Freddie, and Ginnie Mae
- Bassman explains that recent SEC rule changes allowing derivatives in ETFs enabled him to create the first ETF focused exclusively on current-coupon mortgage bonds
- He advocates for selling interest rate volatility through mortgage bonds rather than taking duration or credit risk, arguing that implied volatility is extremely high relative to realized volatility in current market conditions
Topics
Transcript
This is Macro Voices, the free weekly financial podcast targeting professional finance, high net worth individuals, family offices, and other sophisticated investors. Macro Voices is all about the brightest minds in the world of finance and macroeconomics telling it like it is, bullish or bearish, no holds barred. Now, here are your hosts, Eric Townsend and Patrick Ceresna. Macro Voices episode 449 was produced on October 10th, 2024. I'm Eric Townsend. Simplify Asset Management's convexity maven, Harley Bassman returns as this week's feature interview guest. And our topic will be mortgage-backed securities and how to trade them. And I'm Patrick Ceresna with the Macro Scoreboard. Week over week, as of the close of Wednesday, October 19th. Just a heads up,…
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