Regan Floating Rate MBS ETF (MBSF)

The Regan Floating Rate MBS ETF (ticker MBSF) holds agency mortgage-backed securities whose interest rates adjust periodically, typically quarterly or monthly, based on reference rates like SOFR or the one-month LIBOR equivalent. Where traditional MBS are fixed-rate — the homeowner pays the same rate for the life of the loan — floating-rate MBS are backed by adjustable-rate mortgages (ARMs), and those adjustments pass through to the security holder.

When the Fed raises rates, floating-rate MBS coupons rise almost immediately — a built-in hedge against the interest-rate risk that fixed-rate bondholders face.

The mechanics of floating-rate MBS

An adjustable-rate mortgage (ARM) is a home loan whose interest rate starts low but resets at specified intervals — typically annually, but sometimes more often — to reflect current market rates. The borrower benefits from the initial low rate; the lender (and ultimately the mortgage-backed-security holder) benefits when rates rise, because the coupon resets higher.

Securities backed by these ARMs pass the coupon adjustments directly to bondholders. If the ARM resets quarterly to the three-month SOFR rate plus a margin, the MBS security adjusts quarterly too. This means the cash flow the investor receives changes as rates change, creating a bond whose yield is not fixed but floating.

The structure solves a particular problem. Fixed-rate MBS investors face duration risk: when rates rise, the value of the bond falls because the fixed coupon becomes less attractive. Floating-rate investors do not have that problem, because their coupon adjusts upward as rates rise, keeping the price relatively stable. The trade-off is that the average coupon is lower than what a fixed-rate MBS would offer at the same point in time, because the ARM and the floating-rate MBS embody optionality (the borrower can refinance if rates fall) that fixed-rate borrowers do not have.

Why a fund would hold floating-rate MBS

Investors hold floating-rate MBS in environments where they expect rising interest rates or where they want to reduce the duration risk of a fixed-income portfolio. A bank holding a portfolio of floating-rate MBS has natural protection if it is also funding itself with floating-rate deposits or borrowing; the interest-rate moves that widen funding costs are matched by wider spreads on the MBS side.

For individual investors in a mutual fund or ETF, floating-rate MBS make sense as a diversifier: they behave differently from fixed-rate bonds. In a rising-rate environment, a portfolio of floating-rate and fixed-rate MBS hedges itself better than either one alone. In a falling-rate environment, fixed-rate MBS outperform because their coupons stay high while floating-rate coupons fall. Neither one “wins” in all environments.

The reality of floating-rate floors and spreads

Floating-rate MBS are not pure interest-rate adjustments. Most ARMs include a floor — a minimum coupon below which the rate cannot fall — so that if short-term rates collapse (as they did during the pandemic), the homeowner still owes a specified minimum and the security holder still earns a minimum coupon. This floor matters because it means floating-rate MBS are not truly risk-free when rates fall; they continue earning the floor coupon even as short-term rates decline toward zero.

The coupon also includes a spread — a fixed margin above the reference rate, set at origination. A mortgage that resets to “one-month SOFR plus 2.75%” will always pay that 2.75% premium plus the current SOFR, even as SOFR moves. That spread compensates the investor for credit risk (even on agency MBS, there is a small risk premium embedded), liquidity risk, and the option risk embedded in the ARM itself.

Size and liquidity of the floating-rate MBS market

Floating-rate MBS are a smaller part of the overall agency MBS market than fixed-rate MBS, but they remain substantial. ARMs have cycled in and out of fashion depending on prevailing rates and economic conditions. When fixed rates are exceptionally high, more borrowers choose ARMs; when fixed rates are low, ARMs become less attractive to originators and borrowers alike. Because ARMs are a smaller niche, floating-rate MBS are less liquid than fixed-rate MBS, which can show up in slightly wider bid-ask spreads and smaller fund inflows and outflows.

MBSF, as an ETF, provides a liquid secondary market for investors who do not want to buy and hold a static pool of floating-rate MBS. The fund creates and redeems shares on an ongoing basis, making it easy for investors to move in and out.

The risks specific to floating-rate MBS

The main risk is spread widening: if credit conditions deteriorate or if the market simply becomes less interested in floating-rate MBS, the spread (the premium above SOFR) can widen, and the market value of the fund’s holdings can fall. This is not duration risk (the principal amount does not change as rates move), but it is still price risk.

A second risk is coupon floor constraint: if short-term rates remain low or fall further, the floating-rate securities may not be able to offer higher yields because they are stuck at the floor, so the portfolio’s attractiveness versus fixed-rate bonds deteriorates.

Finally, there is reinvestment risk of a different kind: investors who hold floating-rate MBS expecting rising rates get higher coupons, but if rates fall again, the reinvested coupons come in at lower rates, and the cost of that reinvestment risk is borne by the security holder.

How to evaluate MBSF and similar floating-rate funds

Start with the fund’s fact sheet and prospectus to understand the specific index or methodology it uses to select ARM-backed MBS. Note the current distribution rate and the average reset frequency (quarterly, annually, or mixed). Check how the fund has performed in rising-rate and falling-rate environments — the outperformance in a rising-rate period should be clear and measurable.

Compare MBSF’s expense ratio to that of other floating-rate MBS funds and to mixed fixed/floating MBS portfolios. The cost of the fund matters because spreads in the MBS market are tight; a fraction of a basis point in expense ratio is material to net performance.

Research the composition of the holdings: are they mostly current-coupon ARM mortgages, or a mix of older and newer ARMs? Older ARMs with higher coupons may have already been refinanced, leaving a pool biased toward newer, lower-coupon mortgages. Newer originators and lower coupons affect the prepayment risk profile. Finally, monitor the spread between the fund’s yield and short-term rates (such as the Fed funds rate or three-month SOFR), as a widening spread indicates the market is demanding more compensation, often a sign of softening demand for ARM-backed securities.