- ETFs holding US mortgage-backed securities recorded $2.4 billion of net outflows in September, the most since March 2020, as Treasury yields reached multi-decade highs on expectations of further Federal Reserve tightening.
- BlackRock iShares MBS ETF, known as MBB, fell roughly 3% on a total return basis for the month and shed about $2.7 billion, its largest monthly outflow since inception. It lagged the broader US bond market fund, which was down 2.4%. Investors also pulled a record $342 million from the Simplify MBS ETF and $245.8 million from the Schwab Mortgage-Backed Securities ETF.
- A significant portion was internal reallocation rather than investor flight. BlackRock model allocation team sold over $1 billion of the passively managed MBB and moved into the firm own actively managed MBS ETF, which took in about $560 million during September.
- James Seyffart, ETF analyst at Bloomberg Intelligence, said rate volatility is bad for all debt but particularly for mortgage securities because of prepayment behaviour, and that with Treasuries now yielding more than 5% the case for accepting MBS complexity becomes harder to make.
What Happened?
Mortgage-backed securities perform poorly when yields move sharply in either direction. In a rising rate environment homeowners stop refinancing, which leaves investors holding securities paying below-market yields for longer than expected. A widely watched gauge of bond market volatility has risen in recent weeks and sits near its April highs.
Why It Matters?
The headline overstates the investor verdict. MBB alone lost $2.7 billion while the entire category lost $2.4 billion net, which means other mortgage funds took money in, including BlackRock own active product at $560 million. More than a billion of MBB outflow came from BlackRock model allocation team moving between its own funds, so a meaningful share of what reads as investors abandoning mortgage debt was one asset manager switching from a passive wrapper to an active one. That matters twice over. It tempers the conclusion about sentiment toward MBS, and it is the second documented case this month of BlackRock model reshuffles moving billions through specific funds, after the same team pushed over $4 billion out of a momentum ETF and into a country rotation fund. Investors holding any fund heavily represented in third-party model portfolios carry flow risk that has nothing to do with the underlying asset. The investment argument Seyffart makes is the durable one. Mortgage securities compensate investors for prepayment uncertainty, and when Treasuries yield above 5% without that complexity, the spread has to widen materially to justify the trade. The current environment is the worst case for the asset class: rates rising sharply, refinancing collapsing with applications down 8.7% and the 30-year mortgage at 7.28%, which extends duration precisely when holders would prefer their capital back. MBB underperforming the aggregate bond index by 60 basis points in a single month is that extension risk showing up in returns. For allocators the practical question is whether current spreads compensate for it, and the flow data does not answer that.
What Next?
Watch whether October outflows continue once the BlackRock reallocation is complete, since that will separate genuine investor sentiment from internal fund switching. The path of Treasury yields determines everything here, and the softer inflation print reducing October rate hike expectations would be the first relief for the asset class. Refinancing activity is the specific variable to follow, because any decline in mortgage rates that restarts prepayments changes MBS duration quickly in the other direction. Spreads over Treasuries are the measure of whether the asset class has repriced enough to attract buyers back, and that is more informative than fund flows. Also watch whether other model portfolio providers make similar passive to active switches in fixed income, which would indicate a broader shift rather than a single firm decision.
Affected Tickers and Coins: MBB, AGG, MTBA, SMBS, BLK, SCHW
Source: Bloomberg
