Passive investment strategies such as “Buy and Hold” are frequently ineffective in volatile financial markets and changing economic circumstances such as interest rate fluctuations. For specialized assets such as residential mortgages, an active investment strategy can have benefits such as the following:
- Adding the potential for hedging strategies at opportune times.
- Repositioning portfolios to reflect new circumstances.
- Using periodic pricing discrepancies to purchase assets.
- Avoiding or minimizing excessive financial impacts due to unexpected events.
- Facilitating cash flow improvements and capital appreciation opportunities.
- Monitoring financial markets for new opportunities.
These potential benefits are discussed in the following overview.
Six Benefits of an Active Management Style for Residential Mortgage Loans
Here are some of the primary advantages that can accrue from actively managing residential financing investments:
Apply a Hedging Strategy — In simplest terms, the process of hedging investments usually involves insuring against a negative event. Investors periodically hedge one asset by investing in another asset. The willingness to use a hedging strategy can be particularly useful if investments increase or decrease in value when events like interest rate changes occur. For example, mortgage servicing rights (MSRs) are assets that typically increase in value when interest rates go up while valuations of fixed-rate mortgages usually decline under the same scenario.
Reposition Portfolios — One of the most prudent attributes of active investment management is the ability to rebalance portfolio weightings as conditions change. One illustration is reducing cash positions and increasing holdings in undervalued non-agency residential mortgage-backed securities (RMBS).
Purchase When Sellers Are Forced to Dispose of Assets — A common scenario involving securitized mortgages is forced selling by some institutional investors. The underlying reasons include such factors as requirements to raise capital and rating downgrades. For investors with ample capital resources, this frequently produces a temporary pricing discrepancy and buying opportunity.
Monitor for Unexpected Circumstances — Regardless of how much advance due diligence and investment analysis is applied, investors should always be prepared for the unexpected. As observed by Leo Rosten, “Some things are so unexpected that no one is prepared for them.” Actively managing assets creates a mentality that fosters the willingness to incorporate the unexpected into ongoing investment decisions.
Enhance Cash Flow Whenever Feasible — Improving cash flow is always a smart idea, but opportunities to do so are severely limited with a passive investment approach. With residential real estate loans, purchasing MSRs and call rights are two examples of enhancing cash flow and capital appreciation scenarios.
Always Being on the Lookout for New Asset Vehicles — In a dynamic investment environment, it is not unusual to encounter new asset choices. For example, the residential mortgage servicing industry has changed dramatically during the past decade. While banks currently own the majority of mortgage servicing rights, many MSRs are being sold to help financial institutions meet regulatory and capital reserve guidelines.
Potential Limitations and Challenges of Active Asset Management
One recurring potential limitation of active portfolio management is maintaining more cash than is typically held in passive management scenarios. The primary rationale of ample cash positions is to facilitate unexpected buying opportunities — but this can impact investment returns due to reduced earnings from cash holdings. One way that active investment managers like New Residential Investment Corp. overcome this challenge is by issuing new asset-backed notes to finance selective new asset acquisitions.
A second limitation of active investment strategies is that average investors do not always understand the complexities of what is required. For example, active management of specialized residential mortgage assets like non-performing loans and MSRs typically requires advanced knowledge, analysis and coordinated timing to achieve enhanced portfolio returns. Overcoming this challenge ideally involves the ongoing participation of expert managers who are experienced in finding, buying, refinancing, managing and selling residential financing vehicles.
How to Apply Active Investment Strategies to Residential Real Estate Loan Assets
Meeting the challenges described above and simultaneously realizing the potential benefits of actively managing residential mortgages and related assets can be both difficult and time-consuming for average investors. However, investing in a specialized real estate investment trust (REIT) like New Residential Investment Corp. is a viable and prudent alternative to consider.
About New Residential Investment Corp. — Board Chairman/CEO: Michael Nierenberg
New Residential Investment Corp. is a qualified REIT (NYSE: NRZ) that incorporates actively managed non-agency mortgage-backed assets and related residential real estate financing vehicles in their portfolio. The Company is qualified for MSR ownership in all 50 states and is approved to serve as a servicer for Fannie Mae (Federal National Mortgage Association) and Freddie Mac (Federal Home Loan Mortgage Corporation) and as a lender for FHA (Federal Housing Administration).
During a 52-week period ending February 12, 2019, the trading range for NRZ shares was $13.86 to $18.75. As of February 12, New Residential’s stock market valuation was $6.1 billion ($17.10 per share). Recent financial ratios include 3.01 for price/EBITDA (earnings before interest, tax, depreciation and amortization), 7.92 for price/earnings and 101.34 (%) for price/book value. New Residential’s annual dividend (regular cash, paid quarterly) was $2 for 2018 and $1.98 for 2017.