ANDREW LECKEY — Small investors in search of higher yields are turning to adjustable-rate mortgage funds, a relatively new concept that's rapidly gaining steam.
The biggest fund that taps the housing market, Franklin Adjustable U.S. Government Fund, has $3.7 billion in assets and was founded in fall 1987. A number of other funds have joined it, offering the potential for higher yields than money-market funds.
ARM funds invest at least 65 percent of assets in adjustable-rate mortgages, typically issued by a government agency such as the Government National Mortgage Association (Ginnie Mae). Agencies buy mortgages from banks or savings and loans and package them into securities, which are bought by the funds.
"ARM funds are for people dissatisfied with rates on certificates of deposit and money-markets, who want current income but not the risk of principal associated with long-term funds," explained Tony Coffey, co-portfolio manager of Franklin Adjustable U.S. Government Fund.
However, unlike a money-market fund, net asset value of an ARM fund can fluctuate. Yield moves up and down with interest rate trends, the mortgage caps setting upward and downward limits.
Some experts consider ARM funds a stepping stone for investors coming out of money-market instruments and seeking less volatility than a Ginnie Mae fund. But understand them.
"One disadvantage occurs when underlying interest rates move down and ARMs must reset at a lower rate, and, in addition, there's risk of greater prepayment of mortgages in a low-rate environment," observed Don Phillips, publisher of the Chicago-based Mutual Fund Sourcebook.
Here, ranked by asset size by Morningstar, are the 10 largest ARM funds:
* Franklin Adjustable U.S. Government Fund, San Mateo, Calif., $3.7 billion in assets, 3 percent "load" (initial sales charge), $100 minimum initial investment, current 30-day yield of 6.06 percent.
* Merrill Lynch Adjustable-Rate Securities "B" Fund, New York, $700 million assets, 3 percent load, $1,000 minimum, current yield 6.96 percent.
* Asset Management Adjustable-Rate Mortgage Fund, Chicago, $643 million assets, no load, $50,000 minimum, current yield 5.48 percent.
* Fortress Adjustable-Rate U.S. Government Fund, Pittsburgh, $626 million assets, 1 percent load, $1,500 minimum, current yield 5.86 percent.
* Goldman Sachs Adjustable-Rate Government Agency Fund, Chicago, $561 million assets, no load, $50,000 minimum (must be Goldman Sachs client), current yield 6.28 percent.
* Pilgrim Adjustable U.S. Government Securities "I" Fund, Los Angeles, $489 million assets, 4 percent load, $5,000 minimum, current yield 7.87 percent.
* Benham Adjustable-Rate Government Securities Fund, Mountain View, Calif., $444 million assets, no load, $1,000 minimum, current yield 6.76 percent.
* Ranieri Adjustable-Rate U.S. Government "I" Fund, Boston, $291 million assets, 3 percent load, $500 minimum, current yield 7.31 percent.
* Putnam Adjustable-Rate U.S. Government Fund, Boston, $263 million assets, 3.25 percent load, $500 minimum, current yield 6.48 percent.
* Ranieri Adjustable-Rate U.S. Government "II" Fund, Boston, $132 million assets, 3 percent load in first year (2 percent second year, 1 percent third year), $500 minimum, current yield 6.36 percent.