Subprime ETFs: yes, they are a thing

by , 5th September 2017

Subprime mortgages: Everyone knows what they are. They’re the dread, the bad guy. The thing most responsible for the financial meltdown in 2008.

There’s no way they’d ever make a comeback, less still get an ETF erected in their honour. Right?

Wrong.

Subprime mortgages are coming back in a big way (only now they’re called ‘nonprime’ mortgages). According to the Financial Times:

“The sector is on course to produce about $10bn this year — a tiny slice of America’s $1.6tn overall home-loan market but one that’s growing rapidly…The market for securitising subprime loans is picking up, too, spreading the risk of default in much the same way as before.”

And Bloomberg:

“PIMCO, Goldman Sachs, Columbia Threadneedle and others are snatching up bonds tied to subprime mortgages and other home loans made before the housing crisis, while selling speculative-grade company debt.”

So subprime mortgages are returning, on both the buy-side and on the sell-side.

We live in an era in which there is an ETF for anything – from whisky to Libor to marijuana. Wherever there is demand for some kind of financial exposure, it is only a matter of time before an ETF comes along to offer it. And now, to match the rising demand, there is a new ETF that holds subprime mortgages.

New US issuer Spinnaker ETF – about whom there is very little public information at this stage – is set to be the first issuer to dip its toes in the water.

As part of its inaugural listings, Spinnaker is rolling out the Unconstrained Medium-Term Fixed Income ETF (FFIU).

FFIU does not say up front that it can invest in subprime mortgages: its fact sheet mentions only debts with maturities between 5 and 7 years and investment grade mortgages.

But the give-away is both in the name – i.e. the Unconstrained Income ETF is unconstrained – and the prospectus, which states: “The Sub-Adviser considers all mortgage-backed securities to be eligible for purchase regardless of their credit rating or lack thereof.”

In other words, FFIU can invest in subprime mortgages.

In fairness, FFIU caps its subprime exposure at 20%; the other 80% of the fund has to be BB+ rated mortgage securities. But given the history, that even 20% is allowed is a development.

FFIU will not be for the fainthearted (a fact surely realised by the issuer themselves given the total cost is 1.23%). And maybe it will succeed, both in NAV and in the assets it collects. But it should come with a warning.

When the 2008 financial crisis came crashing in, the ETF industry was still small. And because most ETFs were physical index trackers or backed by gold bullion, ETFs escaped the stigma that was plastered on structured credit and derivatives.

With the rise of subprime ETFs, if the 2008-style subprime crisis were to re-occur – which it still could – ETFs might not get out so easily.

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