Bill Gross is one of Wall Street's most renowned bond investors. Nicknamed the "Bond King," Gross co-founded global fixed-income investment company PIMCO. Suffice it to say he knows something about income investing.
Gross recently highlighted a high-income, high-upside opportunity in the mortgage bond market: Mortgage REITs. In particular, Gross pointed to Annaly Capital Management(NYSE: NLY) and AGNC Investment(NASDAQ: AGNC) as mortgage REITs that could deliver significant total returns in 2024.
The lost decade
In a post on Elon Musk's X (formerly Twitter), Gross didn't mince words when discussing the recent past of Annaly and AGNC. He noted: "Mtge REITs like NLY and AGNC have been terrible investments over the past 10 years."
That's evident in the following chart:
Their stock prices have lost more than half their value over the past decade. The only saving grace has been their high-yielding dividend payments, which pushed their average annualized total return into the low single digits (still woefully underperforming the S&P 500).
One of the issues facing these REITs over the years has been changes in interest rates. The companies buy mortgage-backed securities (MBS) backed by government agencies using a lot of leverage. Until last year, mortgage rates had been on a steady decline over the past decade:
30 Year Mortgage Rate data by YCharts
That enabled borrowers to refinance at a lower rate. As borrowers paid off higher-yielding loans, the REITs' only choice was reinvesting their capital at lower yields. While the REITs could also borrow money at lower rates, the compression in rates narrowed the spread between where they borrowed money and the interest they earned on their MBS investments, reducing their income. As a result, both REITs have cut their dividends a few times over the past 10 years.
Why 2024 could be different for these mREITs
While the past decade has been rough for investors in Annaly and AGNC, Bill Gross wrote on X that he expects "2024 should be different." He pointed out, "With 14% and 16% yields, respectively, they should be positively affected by lower 10 year Treasury yields." That's because yields (on dividend stocks and fixed-income investments) move in an inverse relationship to the value of the underlying investment. So, if the yield is moving lower, the market value of the income-producing investment would be on the rise.
For example, if the Federal Reserve lowers interest rates next year, the yields on income-focused investments (like the 10-year Treasury) would also likely fall. That happens as the market value of treasury notes rises. With treasury yields down, investors seeking yield will look elsewhere for a higher-yielding income stream. As such, they'll likely start bidding up other yield-focused assets, like Annaly and AGNC, causing their stock prices to rise and dividend yields to fall.
In Bill Gross' view, "prices in 2024 could go up by 10%." Add their double-digit dividend yields, and these REITs could produce total returns approaching 25%.
However, Gross does warn that their share prices could take a hit in the near term as some investors sell before the end of the year for tax loss harvesting. That makes buying near the end of the year or early next year an ideal time for starting a position in these mortgage REITs for a potential high total return in 2024.
A high-risk, high-total return opportunity
Bill Gross believes that mortgage REITs Annaly Capital Management and AGNC Investments look like compelling investment opportunities heading into 2024. Falling rates should drive up the value of yield-focused investment vehicles, with the share prices of these REITs potentially rising by 10%. Add their high dividend yields, and these REITs could produce total returns above 20%.
However, while that's an enticing return, investors need to be aware of the risks, including that these REITs have a history of delivering woeful underperformance. Investors need to have a high-risk tolerance before buying shares of these high-yielding REITs.
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Matthew DiLallo has positions in Annaly Capital Management. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.
