Preparing for the unexpected and taking an adaptive investment approach are central to strategy at Dynex Capital, Inc. (NYSE: DX), says the mortgage REIT’s co-CEO Smriti Laxman Popenoe.
Popenoe adds that identifying and investing in markets and assets that offer strong hedged or risk-adjusted returns, even in a challenging economic environment, underlie the mREIT’s continued success.
With more than 30 years of experience in capital markets and investing, including senior roles at Wachovia and Freddie Mac, Popenoe was promoted to co-CEO, alongside Byron Boston, in July. She also holds the positions of president and chief investment officer. REIT.com spoke to Popenoe about her new role and where she sees opportunity ahead.
How has your promotion to co-CEO affected your day-to-day activities?
The promotion to co-CEO has certainly brought about a shift in my day-to-day activities. While I continue to fulfill my responsibilities as president, CIO, and board director, my role now involves a greater focus on strategic leadership and decision-making at the highest level.
This includes collaborating closely with my co-CEO Byron Boston to steer the company towards its long-term goals, ensuring alignment across all departments, and maintaining a strong connection with our stakeholders. Balancing these roles requires time management, prioritization, delegating the right things, and managing resources effectively. For me, the most important aspect is the unique opportunity to shape Dynex’s future and drive the company forward.
How have the last few years, starting with the collapse of Silicon Valley Bank, First Republic, and other middle market banks, coupled with higher inflation and rising interest rates, impacted your investment thesis?
Our investment process has always been top down, starting with global macroeconomics and very thorough scenario analysis. We also spend time preparing mentally for what our actions will be when faced with unexpected outcomes. The last couple of years have been quite interesting and these events have necessitated a more adaptive investment approach with even more scenario analysis.
The banking crisis of 2022 resulted in really good investment opportunities for Dynex as agency residential mortgage-backed securities (RMBS) spreads widened to very accretive levels versus our cost of capital. We were ready and we deployed capital through that time period.
Going forward, focusing on high-quality assets, and maintaining liquidity to navigate market volatility, remains a focus. Our investment thesis still emphasizes liquidity and risk management, whereas Byron (Boston) and I focus the team on mental resilience and flexibility to adapt to the evolving economic landscape.
We’re now starting to see changes in interest rates, however housing costs and inflation remain high. How does this impact the mortgage market overall, or more specifically the markets that Dynex actively invests in?
We talk a lot about the concept of government policy driving returns. Market returns are being affected by government policy on trade, tariffs, housing, and deficits more so than ever before. So, we are preparing for interest rates to be in a fairly broad range and we believe this is prudent when there is quite a bit of uncertainty on how government policy will evolve.
We are preparing for interest rates to be in a fairly broad range and we believe this is prudent when there is quite a bit of uncertainty on how government policy will evolve.
For Dynex, this means closely monitoring these factors to adjust our investment strategies accordingly. Higher interest rates can lead to reduced mortgage origination volumes and refinancing activities, affecting the performance of mortgage-backed securities (MBS). However, they can also create opportunities for investing in higher-yielding assets. Our focus remains on identifying and investing in markets and assets that offer strong hedged or risk-adjusted returns, even in a challenging economic environment.
What types of initiatives does Dynex take during uncertain economic times to continue to drive performance throughout the portfolio?
We like to think of them as interesting times. My co-CEO and I have been talking about increasing global complexity since 2014 and so our entire business process is built around understanding uncertainty and its impact on our liquidity, risk, and financial position.
We also actively engage with our stakeholders to ensure transparency and build trust. This was especially important during COVID when we ended up having more frequent public calls with our investors, and at that time transparency went a long way.
Are there trends in AI that you are keeping an eye on when it comes to investing?
AI and machine learning technologies can dramatically change decision-making processes for investment managers like us. First in terms of accuracy, if AI can get us 80% of the way and human intervention is only 20% of any given decision, then that is meaningful change that can help us be more confident about the decisions we are making.
Secondly, in terms of speed and efficiency, the faster we can get through basic processes, the more time is freed up for the tougher problem solving and higher-level thinking. AI will be a game changer if applied properly. We have an AI expert on our board to help us think through how this will evolve for our business, and we’re focused on how we can use it to improve the quality and speed of our decision making. AI has the potential to improve prepayment and credit modeling, however, it is yet to be fully applied to these business cases.
One of Dynex’s strategies is investing in agency and non-agency mortgage assets. Are the two asset classes generally correlative or do they tend to be non-correlative, providing a hedge against highs and lows in either market?
Today, our portfolio is almost entirely comprised of agency RMBS. We are the most agency-focused mREIT in the market because agency investments offer the best potential returns relative to the risks. In general, our portfolios at Dynex have been diversified across agencies, non-agencies, commercial, and residential mortgages.
While in principle we do think about diversification, the main driver of capital allocation is risk-adjusted return. Non-agency mortgages, both commercial and residential, sometimes are uncorrelated but at other times they are not. So, we can’t just think of correlation as a reason to own both. It’s really all about where we can earn the best risk-adjusted return.
Given the last couple of years, how are the two asset classes performing now?
Agency RMBS are where we see the most value across the asset classes today. Non-agency RMBS have performed well but risk adjusted returns are still lower—same story with agency and non-agency CMBS. It’s amazing to see the most liquid asset trade the cheapest, but that’s also where the investment opportunity is too.