The Attraction of Mortgage-Backed Securities in a Shifting Yield Environment

In a financial landscape marked by persistent inflation and shifting monetary policy, investors are increasingly scrutinizing yield-enhancing strategies that balance risk and return. Among these, mortgage-backed securities (MBS) have re-emerged as a compelling asset class, particularly for those seeking exposure to fixed-income markets amid rising interest rates. The Schwab Mortgage-Backed Securities ETF (SMBS) stands out as a strategic vehicle for accessing this niche, offering a blend of diversification, affordability, and alignment with macroeconomic trends.

Performance in a Rising Rate Environment

Despite the traditional inverse relationship between bond prices and interest rates, SMBS has demonstrated resilience. As of September 2025, the ETF delivered a 12-month total return of 6.43% and a year-to-date (YTD) return of 6.50%, according to the SMBS performance data, outperforming broader fixed-income benchmarks. This performance is attributed to its focus on the Bloomberg US MBS Float Adjusted Total Return Index, which aggregates investment-grade MBS issued by U.S. government agencies, as noted on StockAnalysis. These securities, backed by entities like Fannie Mae and Freddie Mac, offer a unique risk profile: while sensitive to rate fluctuations, they benefit from prepayment dynamics that stabilize returns during periods of rising rates, as shown in its Yahoo Finance profile.

A critical factor in SMBS's success is its ability to mitigate extension risk-the risk that borrowers delay refinancing as rates rise. In 2023–2025, higher mortgage rates reduced refinancing activity, slowing prepayment speeds and extending the duration of cash flows for MBS holders, a trend highlighted on the Schwab Funds page. This created a favorable environment for SMBS, as the ETF's underlying securities retained value despite broader market volatility. For instance, SMBS's 1-year return of 3.68% (per Schwab) outpaced the Intermediate Government category's 3.19% (reported by Yahoo Finance), underscoring its competitive edge in a challenging yield environment.

Risk Profile and Strategic Advantages

While SMBS is not without risks, its structure positions it as a lower-volatility option compared to equity-based ETFs. Categorized under "Intermediate Government," the fund's exposure to agency-backed MBS reduces credit risk, as these securities are implicitly guaranteed by the U.S. government (per StockAnalysis). However, its sensitivity to interest rates remains a double-edged sword. A notable drawdown of 3.20% occurred in January 2025, though the ETF recovered within 29 trading sessions (per Yahoo Finance), illustrating its capacity to rebound in dynamic markets.

SMBS's low expense ratio of 0.03% (per StockAnalysis) further enhances its appeal, particularly for long-term investors. This affordability, combined with its monthly dividend yield of 3.63% (per StockAnalysis), makes it an attractive option for income-focused portfolios. Additionally, its alignment with the Bloomberg US MBS index ensures broad diversification across a range of mortgage products, reducing idiosyncratic risks associated with individual securities.

Comparative Analysis with Fixed-Income Peers

In a rising rate environment, SMBS distinguishes itself from other fixed-income ETFs by leveraging the unique characteristics of MBS. For example, short-duration ETFs like the iShares 1-3 Year Treasury Bond ETF (SHY) or the Pimco Enhanced Short Maturity Active ESG ETF (EMNT) offer lower interest rate risk but typically generate lower yields (per Schwab). Conversely, SMBS's moderate duration strikes a balance between yield generation and risk management, making it a versatile tool for investors navigating a "higher-for-longer" rate regime (per Yahoo Finance).

Moreover, SMBS's performance contrasts with the Intermediate Government category, which has underperformed over multi-year horizons due to prolonged rate hikes. While the category posted a 5.18% YTD return (per Schwab), its 3-year and 5-year returns were 2.47% and -0.71%, respectively (per Schwab), highlighting the challenges of traditional fixed-income strategies. SMBS, by contrast, has shown stronger near-term returns, suggesting its structure is better suited to capitalize on the interplay between rate hikes and prepayment dynamics (per SMBS performance).

Conclusion

As central banks continue to navigate inflationary pressures, the Schwab Mortgage-Backed Securities ETF offers a compelling case for investors seeking yield in a shifting rate environment. Its ability to outperform broader fixed-income benchmarks, coupled with its low-cost structure and agency-backed collateral, positions it as a strategic asset for diversified portfolios. However, investors must remain mindful of its interest rate sensitivity and the potential for future volatility as monetary policy evolves. For those willing to accept moderate risk in exchange for enhanced yield, SMBS exemplifies how niche fixed-income strategies can thrive in an era of macroeconomic uncertainty.