Whenever you read about a U.S. Treasury auction of notes or bonds -- as you may have done during last week's quarterly refunding of part of the public debt -- you may be tempted to submit a bid yourself.
Sure, their prices will fluctuate until you get your principal back at maturity. Inflation might erode the principal's purchasing power.
Still, you know that there are no safer securities in the world. And by going directly to the source (or the nearest Federal Reserve Bank or branch), you can avoid commissions.
But if you want to own a whole portfolio of Treasury securities that mature in different years, you'll soon learn that you need a considerable amount of money: two- and three-year notes sell for $5,000 apiece, and longer issues go for $1,000.
It may, therefore, occur to you to invest instead in a mutual fund that's concentrated in Treasuries. (Unlike the Treasuries, of course, the fund's shares are not backed by the government.) Your initial investment, instantly giving you a portfolio diversified across a range of maturities, could be modest. You could add to it in small installments. And if you don't need the income, the fund would reinvest it for you -- no matter how low the amount.
If you agree with many forecasters that long-term interest rates will fall, sooner or later, you also may be thinking of "locking in" today's yields.
You can't do this with mutual funds, however. Except for a few, such as Benham's and Scudder's government zero-coupon funds, they never mature. Zero-coupon funds will offer returns until maturity that are reasonably predictable, but their share prices are likely to be volatile, and they pay no current income.
If you want income, you'd have to find a fund that primarily invests in long-term Treasuries. Their dividends should come down more slowly, and their share price should rise the most, when -- and if -- rates do come down.
Of course, should rates rise, the fund's price would fall more than a short- or intermediate-term Treasury fund's -- but not as much as a long-term zero-coupon fund's.
You may be surprised to learn that only a few long-term Treasury funds exist. The largest is Vanguard's $700 million U.S. Treasury Bond Portfolio. Others include Federated's Fortress Total Performance U.S. Treasury Fund, T. Rowe Price's U.S. Treasury Long-Term Fund, and Rushmore's U.S. Government Long-Term Portfolio.
The overwhelming majority of funds in Lipper Analytical Services' U.S. government fund category have policies permitting them also to be invested in other types of government and government-related securities, not just Treasuries.
Since mortgage-backed securities (MBS) have been outperforming Treasuries, it's little wonder that they make up the major portions of many funds' portfolios. MBS include both those guaranteed by the Government National Mortgage Association (Ginnie Mae), which are backed by the full faith and credit of the Treasury, and those guaranteed by the Federal Home Loan Mortgage Corp. (Freddie Mac) and Federal National Mortgage Association (Fannie Mae), which have the government's "moral" backing.
It's also little wonder that the group's leading performers of the last five years, listed in the table, don't include one pure Treasury fund. None of the leaders has more than about 45 percent of its portfolio in Treasuries, as the WPG fund does. Some, such as the First Trust, Value Line and Lord Abbett funds, have only around 10 percent.
A few, such as the Federated, First Trust and Value Line funds, have been increasing their commitment to Treasuries, or, as in Lord Abbett's case, adding to Treasury zero-coupon securities. But they haven't been in a rush. Doubts remain that long-term rates will fall significantly any time soon. As long as Ginnie Maes, for example, continue to provide yields about 1 percent higher than Treasuries of comparable maturity, they seem hard to resist.
Ginnie Maes pay more because they involve prepayment risk: the risk that, when long-term interest rates fall, people will pay off the mortgages behind the securities more quickly. If that happens, holders of Ginnie Maes will have to put the prepayments of principal to work sooner than expected -- at the lower prevailing rates.
If you consider a government bond fund, you must choose
between pure Treasury funds, whose behavior is likely to be more predictable, and well-managed, more diversified funds, whose managers spread their assets between Treasuries and other securities. Because the weighted average maturities of their portfolios differ, you'll want to check on them. You'll want to go out long enough to raise the odds that you'll get the level of return you're seeking -- but not so long that you'll expose yourself excessively to interest rate risk.
One thing you won't have to worry about is whether portfolio managers will find enough Treasury issues to invest in.