What is VABS? (Pros, Cons, and Strategies)

If you're looking to diversify your portfolio with a focus on mortgage-backed securities (MBS) and asset-backed securities (ABS), the Virtus Newfleet ABS/MBS ETF (VABS) could be a potential candidate. This ETF offers exposure to these fixed-income segments, which are backed by pools of loans such as mortgages, auto loans, or credit card debt. Such investments can provide lucrative yields and reduce overall portfolio risk through diversification. In this blog post, we'll take a detailed look into what VABS is, along with its pros and cons, and some effective strategies for investing in it.

What is VABS?

VABS, or Virtus Newfleet ABS/MBS ETF, is an exchange-traded fund managed by Virtus Investment Partners that focuses on asset-backed securities (ABS) and mortgage-backed securities (MBS).

The fund is designed to offer investors diversified exposure to these income-generating asset classes, striving for stability and yield. It essentially pools various debt securities backed by assets such as real estate, automobiles, or consumer credit to offer investors a diversified and potentially high-yield investment.

Key Features of VABS

• Diverse Asset Pool: The ETF includes a variety of ABS and MBS products, providing exposure to multiple sectors like real estate, auto loans, and consumer credit.
• Professional Management: Managed by Newfleet Asset Management, which brings a wealth of experience and expertise in this specialized field.
• Income-Generating: The primary goal of VABS is to generate a steady income for investors through interest payments from the underlying assets.

VABS Composition

VABS holds a diversified array of ABS and MBS securities. These can include residential mortgage-backed securities (RMBS), commercial mortgage-backed securities (CMBS), auto loan-backed securities, credit card receivables, and other asset-backed debt. The fund invests in both agency securities (backed by government agencies) and non-agency securities, offering a balance between credit quality and yield.

Pros of VABS

High Yield Potential

VABS offers an attractive yield potential compared to traditional fixed-income securities like government or corporate bonds. The underlying assets tend to offer higher interest rates, which can translate to higher dividends for the ETF's investors.

Portfolio Diversification

Including VABS in a portfolio can provide substantial diversification benefits. As ABS and MBS have different risk-return characteristics compared to corporate stocks and bonds, they can help reduce the overall portfolio risk.

Professional Management

Being actively managed by Newfleet Asset Management, VABS benefits from professional oversight and expertise, which can help in navigating the complexities of ABS and MBS markets more efficiently than individual investors might.

Lower Interest Rate Sensitivity

ABS and MBS generally have different sensitivities to interest rate changes compared to traditional bonds. This can potentially make VABS less volatile in fluctuating interest rate environments.

Cons of VABS

Complexity and Risk

ABS and MBS are complex financial instruments that require a good understanding of their inherent risks. Factors like prepayment risk, credit risk, and interest rate risk can affect the performance of these securities.

Management Fees

Actively managed funds like VABS tend to have higher expense ratios compared to passively managed ETFs. Investors should evaluate if the potential higher yield justifies the additional cost.

Market Fluctuations

The securities in VABS can be sensitive to economic conditions, particularly those affecting real estate and consumer credit. Market downturns in these sectors can adversely affect the ETF's performance.

VABS Investment Strategies

While VABS offers multiple advantages, it is crucial to approach it with clear investment strategies to maximize its potential benefits and mitigate its risks.

Long-term Income Generation

Given the high yield potential of VABS, it is suitable for investors seeking long-term income. Investors should consider a holding period of at least 5 to 10 years to ride through the economic cycles and benefit from the steady income and potential capital appreciation.

Diversification Strategy

VABS can be an excellent tool for diversifying a portfolio heavily weighted in equities or traditional bonds. By including VABS, you can diversify your income streams and lower overall portfolio volatility.

Regular Monitoring and Rebalancing

Due to the complexity and unique risks associated with ABS and MBS, it is essential to regularly monitor the performance of VABS and rebalance the portfolio as needed. Keep an eye on economic indicators related to the housing market and consumer credit, as these will significantly influence the performance of the ETF.

Complementary Investments

Given its focus on ABS and MBS, VABS can be complemented by investments in other asset classes like equities, government bonds, and corporate bonds to achieve a well-rounded and balanced portfolio.

Risk Management

Allocate a sensible proportion of your portfolio to VABS based on your risk tolerance. While the high yield is attractive, the inherent risks call for a balanced approach. For example, a risk-averse investor might limit their exposure to 10-20% of their total portfolio.

Conclusion

VABS offers an intriguing option for investors looking to diversify their fixed-income assets and achieve higher yields. While it comes with its own set of complexities and risks, the professional management and diversification benefits make it a viable component of a well-diversified portfolio. Understanding the intricacies of ABS and MBS, coupled with a well-thought-out investment strategy, can help investors make the most out of this unique ETF.