Just for Ginnie: Mae 101

04/18/2003 12:00 am EST

Focus:

Walter Frank

CIO, MONEYLETTER

"GNMAs have served low-risk investors well during tough market times; these securities are essentially pools of mortgages that have been bundled together by banks and its lenders and resold as fixed income securities to investors. The Government National Mortgage Agency then guarantees that each month you will receive timely payment of principal and interest. So already, we see two major benefits: they are backed by the full faith and credit of the US government and your principal and interest are guaranteed. Historically, GNMAs have provided higher yields than those on US Treasury obligations with similar maturities. Since 1980, GNMA securities have yielding between 0.8% and 2.3% more than ten-year Treasury notes.

"GNMAs do have their drawbacks, First, determining the exact yield at any given point is difficult, due to the impact of prepayments on the amount of income investors receive each month. Prepayment risk is a real concern; if borrowers prepay their mortgages faster than anticipated, the investor gets larger monthly payments (as a greater portion of principal is paid off) and future payments will decrease. Meanwhile, the wave of mortgage refinancings should be nearing an end and with rates so low, the next major trend in interest rates is likely to be higher. In that instance, Treasury bonds will suffer but GNMAs should hold up better. The reason? Prepayment risk is greatly reduced when interest rates head up.

"When investing in GNMAs, a mutual fund is generally the way to go. After all, the reinvestment of those principal and interest payments is done for you. One of the best is TCW Galileo Total Return Bond Fund (TGLMX ). Don't let its name fool you. It is a GNMA fund with a name change. Lead portfolio manager Jeffrey Gundlach emphasizes that the managers aim to outperform both the PIMCO Total Return Bond Fund and the Vanguard GNMA fund over trailing three-year time frames. Gundlach and TCW team have certainly been successful. For the trailingone-, three-, and five-year periods, the fund has outpaced at last 96% of the funds in the Lipper US mortgage fund category."

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