The mad dash out of low-rate certificates of deposit has boosted popularity of mutual funds that invest in mortgage-backed securities such as Ginnie Maes. Assets of these funds have grown $10 billion in the last year to reach $57 billion, a result of higher yields than those of competing investments.
Though backed by the government against default, however, securities issued by Ginnie Mae (Government National Mortgage Association) really aren't as risk-free as CDs.
The Ginnie Mae fluctuates in value of assets and in yields. When interest rates decline, as they have been doing, there's risk of repayment of mortgages in the pool by the nation's borrowers. That translates into declining returns from lower-interest mortgages.
"Investors have benefited tremendously from returns of 12 percent or more from mortgage-backed funds, but, looking forward, such returns are going to be harder to come by," notes James Conroy, portfolio manager for Shearson Managed Governments Fund. "I now think that if you get 9 percent, that's a good number and certainly better than you're getting in conventional short-term rates."
The decline in return has begun and will continue.
Returns of the last 12 months are unsustainably high, and the investor should realize that they aren't what should be expected for the coming 12 months," warns John Rekenthaler, editor of the Morningstar Mutual Funds publications.
Understand what a mortgage-backed security is. You're buying a share in a package of fixed-rate home mortgages.
Ginnie Maes are the only mortgage securities that carry the same unconditional federal government guarantee as Treasury bonds. Mortgages are insured by the Federal Housing Administration or Veterans Administration. Ginnie Mae guarantees the securities and the federal government backs Ginnie Mae.
Actual Ginnie Maes require a hefty investment of $25,000. Principal is usually paid back along with regular interest payments, so when you receive your final check you have nothing left. Ginnie Mae mutual funds, on the other hand, invest in a pool of Ginnie Maes and often permit investment of $1,000 or less. They typically allow check-writing.
Popular kin of Ginnie Maes are in many portfolios. Freddie Mac (Federal Home Loan Mortgage Corp.) and Fannie Mae (Federal National Mortgage Association) both issue mortgage-backed securities similar to Ginnie Maes. But their pools are made up mostly of conventional, rather than insured, loans.
Fannie Mae guarantees that investors receive their fair share of interest and principal every month even if homeowners don't meet obligations. Freddie Mac guarantees only timely payment of interest, and the ultimate payment of principal could be delayed if homeowners don't make mortgage payments on time.
Another mortgage-backed portfolio investment, the collateralized mortgage obligation (CMO), has ignited criticism. Each CMO security drawn from a pool of residential mortgages has a unique claim on interest and principal. In more volatile examples, swings in interest rates can postpone final payoff more than a decade or greatly shorten maturities.
Top performers in total return the last 12 months among funds which emphasize mortgage-backed securities such as Ginnie Maes, according to Morningstar, were:
* Managers Intermediate Mortgage Securities, Norwalk, Conn., $110 million in assets, no "load" (initial sales charge), $10,000 minimum initial investment, up 17.72 percent.
* Lord Abbett U.S. Government Securities, New York, $2.7 billion in assets, 4.75 percent load, $500 minimum, up 15.69 percent.
* Kemper U.S. Government Securities, Chicago, $6.45 billion in assets, 4.5 percent load, $1,000 minimum, up 15.53 percent.
* Shearson Managed Governments, New York, $530 million in assets, 5 percent load, $500 minimum, up 15.52 percent.