Salient to Investors:

Mortgage REITs yield 13 percent versus 3.8 percent for T-Bonds.

In 2013 mortgage REITs lost 3 percent on average even after factoring in double-digit dividend yields – versus 30 percent for the S&P 500.

Michael Widner at KBW Bank said the average mortgage REIT trades at a 20 percent discount to book value, and expects mortgage REITs to return over 20 percent in 2014. Widner does no expect the stock market replicating its 2013 returns in 2014.

David Cohen at the Eudora Fund is not concerned about higher rates because mortgage REITs are not really bond funds, but are businesses that use complex hedging strategies to protect themselves from rate increases.

The spread between long-term rates and short-term rates determine a mortgage REIT’s profitability, and not a single interest rate, because REITs borrow short-term and buy long-term bonds. Cohen said the yield spread between 3-month Treasuries and 10-yr T-notes has almost never been wider in the last 35 years.

Any rise in long-term rates that results from Fed cutting QE would increase the yield spreads mortgage REITs can earn. Homeowners tend to pre-pay their mortgages when rates are low, which hurts mortgage-bond investor returns, while rising long-term rates discourage refinancings.

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