MBS ETFs Extend Rally After Best Year Since 2002

Agency mortgage-backed securities climbed more than 8.5% in 2025, their strongest annual return since 2002. Exchange-traded funds that invest in agency MBS have extended gains in 2026 as the market sees stabilizing interest rates, a steeper Treasury yield curve and persistent demand from government-sponsored enterprises.

Futures markets price fewer than two rate hikes through the end of 2027, and the Federal Reserve’s dot plot indicates fewer than two cuts in that period. That range-bound outlook and steady Treasury yields have reduced the value of the homeowner refinancing option and lowered MBS negative convexity, which can limit sharp duration swings for mortgage bonds.

Supply and demand dynamics are also affecting the market. New agency issuance has been unusually low, some banks are increasing holdings of mortgage securities, and the GSEs have a roughly $200 billion balance-sheet pledge that institutional traders cite as a stabilizing source of demand. At the same time, yields on government-guaranteed MBS have remained relatively attractive versus many investment-grade corporate bonds.

Index-style MBS ETFs remain the largest vehicles. The iShares MBS ETF (MBB) holds nearly $40 billion in assets. The Schwab Mortgage-Backed Securities ETF (SMBS), launched in late 2024, has grown to about $6.5 billion and carries a 0.03% expense ratio. Active strategies have attracted flows as well: the PIMCO Mortgage-Backed Securities Active ETF (PMBS) manages roughly $1.3 billion and recorded more than $800 million of inflows over the past 12 months; its fee is 0.71%.

Active managers aim to add value by selecting among mortgage pools and by managing convexity and duration more precisely than passive funds tied to broad benchmarks. They may rotate into non-agency or structured mortgage opportunities and use bond trades to adjust exposure. Dan Hyman, PIMCO managing director and lead portfolio manager, noted, “We continue to see good opportunities in the agency mortgage in 2026, with valuations on average looking cheap and differentiation of bonds within the market creating good relative value opportunities for active managers.”

Portfolio managers identify key risks as a sudden change in Fed policy that pushes long-term rates sharply higher, or a jump in prepayment activity if mortgage rates fall. So far in 2026, the combination of range-bound short-term policy expectations, a steeper yield curve and ongoing demand from GSEs and institutions has coincided with continued ETF gains.