Lower lending rates are particularly tough on shareholders of mutual funds and exchange-traded funds that ply the giant and unpredictable mortgage market. Yet the best of these specialized funds should be able to cherry-pick attractive mortgage-backed securities and ride out this tough rate environment.

“Mortgage funds will tend to do better over longer periods of time or during periods of relative stability because the excess yield will help to drive returns,” said Scott Buchta, head of investment strategy at institutional brokerage Braver Stern Securities.

Manager experience counts, especially with the U.S. government’s actions to loosen credit and spur lending. The Federal Reserve’s decision this week to invest proceeds from its mortgage-backed securities portfolio into Treasurys helped send yields on some shorter-term Treasurys to new depths.

Moreover, lawmakers are debating changes to government-owned enterprises Fannie Mae /quotes/comstock/11k!fnma (FNMA 0.38, -0.01, -1.37%) and Freddie Mac /quotes/comstock/11k!fmcc (FMCC 0.40, 0.00, 0.00%) , the nation’s biggest issuers of mortgage-backed securities, that could slam a door on mortgage-fund shareholders. Read Special Report on legislative battle for Fannie, Freddie.

Mortgage-backed securities funds have gained about 6% on average so far this year, though they’ve underperformed Treasury funds for the past several weeks, according to fund-tracker Lipper Inc.

Mutual-fund selling could continue, particularly if low rates spur refinancing and if a Fannie and Freddie remodeling includes debt forgiveness — as some observers fear. That prospect alone is enough to cast a long shadow over MBS funds. Read more on what would happen to mortgage rates if Fannie, Freddie disappear.

Yet mortgage experts say income-seeking fund investors should look beyond these short-term headwinds even if they pick up strength. MBS funds boast higher yields than comparable Treasurys and much of the income comes with federal government support. Read Bond Report for more on record Treasury yields.

Said Buchta: “Find a manager who’s been through cycles.”

With that in mind, here are five MBS mutual funds and exchange-traded funds to consider:

1. DoubleLine Total Return Bond

After a storied run at asset-management giant TCW, veteran bond-fund manager Jeffrey Gundlach and partner Philip Barach, along with much of their research team, left their duties at TCW Total Return Fund /quotes/comstock/10r!tglmx (TGLMX 10.26, +0.01, +0.10%) and opened their own firm, DoubleLine Capital.

DoubleLine Total Return Bond Fund /quotes/comstock/10r!dltnx (DLTNX 10.87, +0.02, +0.18%) came to market in April and so far has rewarded its early adopters, up 11% since the launch. The outsized return is indicative of Gundlach’s boldness. Unlike most of its rivals, which lean to pools of highly-rated mortgages backed by government agencies Ginnie Mae, Fannie Mae and Freddie Mac, the DoubleLine fund takes an aggressive stance in low-rated non-agency MBS.

About 55% of the portfolio, Gundlach said, is in these riskier plays, including subprime and so-called Alt-A mortgages, which are more illiquid than government-backed debt. As a result, non-agency MBS offer significantly higher income potential: the Total Return portfolio sported a hefty 12% yield at the end of July.

The non-agency MBS universe, Gundlach said, has some powerful technical drivers. “There’s no supply,” he said. “It’s the highest-yielding market and its supply/demand condition is powerfully favorable and very unlikely to change anytime soon.”

Yet Gundlach and his team are known for being able to handle risk. “This fund is better equipped than most to navigate the challenges,” wrote Sonya Morris, an analyst at investment researcher Morningstar Inc., in a recent research report. Still, she added, “Investors shouldn’t be surprised if it encounters bumps along the way.”

2. Metropolitan West Total Return Bond

Metropolitan West Total Return Bond Fund /quotes/comstock/10r!mwtrx (MWTRX 10.57, +0.02, +0.19%) was a strong rival to Gundlach’s offering when he was at TCW. Now Gundlach is at DoubleLine and TCW owns MetWest.
Fortunately for shareholders, the MetWest fund’s longtime managers stayed on, and the fund is still a formidable challenger to DoubleLine.

“It’s business as usual at MetWest Total Return, and that’s a good thing,” Morris, the Morningstar analyst, wrote in a recent review. “The change in ownership has had no impact.”

The fund mixes traditional agency-backed debt with a healthy dose of lower-quality non-agency issues. As of June 30, the portfolio’s average duration — a measure of interest-rate sensitivity — was around four years with a yield of about 4.2%.

The managers have skillfully handled the fund’s additional volatility, keeping portfolio risk average while delivering high long-term returns, Morningstar reports. Results this year so far have been superior, with the fund gaining 9.7%.

“This is a topnotch core bond holding for all but the most risk-averse investors,” Morris noted. Accordingly, Morningstar gives the fund its highest “analyst pick” rating.

3. Pimco Mortgage-Backed Securities

Pimco Mortgage-Backed Securities Fund is a “hidden gem,” wrote Morningstar analyst Eric Jacobson in a recent research report. The fund /quotes/comstock/10r!pmrax (PMRAX 11.10, +0.03, +0.27%) and its manager Scott Simon, Jacobson added, “are one of the best combinations that you may have never heard of.”

Nowadays, Simon is navigating a challenging environment by steering clear of premium-priced debt, which dangles a tempting yield but runs the risk of losing value if the bondholders are paid at par — a trade-off that Simon said he’s unwilling to make.

In addition to holding triple-A securities, the portfolio’s duration is on the short end at about two years. Moreover, riskier non-agency debt is kept to a minimum. “We try to maintain a pretty high credit quality,” said Simon, who also runs sibling Pimco GNMA Fund /quotes/comstock/10r!pagnx (PAGNX 12.12, +0.04, +0.33%) , which is dedicated to Ginnie Mae-backed mortgages.

Accordingly, the MBS fund’s volatility should be low, and its recent yield of about 2.9%, reflects its moderate posture. The fund’s year-to-date 7.9% return, therefore, is indicative of Simon’s ability to identify mispriced securities and other mortgage- market inefficiencies.

4. Vanguard Mortgage-Backed Securities ETF

This intermediate-term oriented portfolio is concentrated, with just 23 positions, but shareholders of Vanguard Mortgage-Backed Securities ETF /quotes/comstock/15*!vmbs/quotes/nls/vmbs (VMBS 51.44, +0.07, +0.14%) are getting the research strength and low cost for which mutual fund giant Vanguard Group is known.

The ETF, which came to market in November 2009, has a broader mandate than Vanguard’s highly regarded and established Ginnie Mae mutual fund /quotes/comstock/10r!vfiix (VFIIX 11.09, +0.03, +0.27%) . That portfolio invests primarily in Government National Mortgage Association pass-through securities and warrants a closer look if you want exposure to this highest-quality part of the mortgage market.

About half of the ETF is given to mortgage-backed securities in a three- to five-year maturity range, with nothing over 10 years. All of these bonds are issued by Ginnie Mae, Fannie Mae or Freddie Mac, with about two-thirds of the portfolio (as of June 30) in agency mortgage-backed pass-through securities.

Except for a sliver in agency debt, the fund’s remaining assets are invested in collateralized mortgage obligations. CMOs have qualities of bonds and pass-throughs, but their cash flow and stability is more varied and complex than basic pass-throughs.

In general, the ETF maintains a short duration of about two years, meaning that it can be flexible under changing conditions, and recently yielded about 2.1%.

As a plus, the ETF’s annual expenses, at 0.15% of assets, are rock-bottom. Costs are crucial with bond funds especially, since returns are typically in the single digits. For the year so far, Vanguard Mortgage-Backed Securities is up 5%.

5. iShares Barclays MBS Bond ETF

The top holdings in this ETF are securities backed by Fannie Mae, representing 52% of the portfolio, with one-third of assets in Freddie Mac mortgages and the remainder in Ginnie Mae-backed securities.

But in stark contrast to the Vanguard ETF, the majority of iShares Barclays MBS Bond ETF /quotes/comstock/13*!mbb/quotes/nls/mbb (MBB 109.71, +0.30, +0.27%) , about 84% of assets at the end of July, was exposed to CMOs, with the remainder in mortgage pass-through securities.

The Barclays ETF, which carries a 0.33% expense ratio, maintains a low duration of just over two years and recently sported a 3% yield. The fund is up 5.4% so far this year.