GNMA funds offer good yields with security of U.S. guarantee


When you look for a mutual fund offering relatively high yields, you ordinarily think of one invested in securities having long maturities or inferior credit quality.

You may be happily surprised to realize that there's a category of funds that may meet your income requirements while being concentrated in issues having less risky, intermediate maturities and -- best yet -- having the highest credit quality: GNMA funds.

GNMA funds buy primarily, if not exclusively, a type of mortgage-backed securities known as Ginnie Maes. Ginnie Maes are securities whose interest and principal payments are guaranteed by the Government National Mortgage Association, a wholly owned government corporation.

The guarantee makes the securities (but not, of course, the funds' shares) as safe and as liquid as Treasury obligations.

Issued by GNMA-approved mortgage companies and other financial institutions, Ginnie Maes represent interests in pools of home mortgages that are insured by the Federal Housing Administration or guaranteed by the Department of Veterans Affairs.

The minimum denomination for Ginnie Maes is $25,000. But by buying shares of a fund that invests in them, you can obtain a piece of one for as little as $1,000 (or less) -- and avoid the chores associated with collecting and reinvesting monthly mortgage payments.

Since Ginnie Maes are backed by the full faith and credit of the United States -- just like Treasury securities -- you may wonder why their yields tend to run 1 percent or more above those of Treasury bonds of comparable maturity.

Is there a catch? There is.

Although free from credit risk, they are subject to interest rate and prepayment risks.

When interest rates rise, the prices of Ginnie Maes -- and GNMAfunds -- fall, just as Treasury bonds do.

But when interest rates fall, their prices don't rise as much as bonds because of prepayment risk. More homeowners pay off their mortgages early, and holders of Ginnie Maes -- including GNMA funds -- have to put the unexpected cash to work at the lower interest rates then prevailing. (Although its underlying mortgages may run for up to 30 years, the expected life of an average Ginnie Mae is close to 12 because of prepayments.)

Investors in Ginnie Maes apparently have felt the additional 1 percent or so of interest has compensated them adequately for accepting prepayment risk. Since their conception in 1970 as a means of attracting more capital into the mortgage market, GNMA has guaranteed about $650 billion of these securities. About $410 billion worth are still outstanding.

No investors have been more enthusiastic in snapping up Ginnie Maes, now being issued at a rate of $4 billion to $5 billion each month, than GNMA funds. That's because the funds, in turn, have been attracting cash from eager buyers.

Sales of shares in such mutual funds totaled $3.4 billion in the first four months of this year, up 93.9 percent, according to the Investment Company Institute. In 1990, share sales were up 47.4 percent.

Among the 40 funds classified as GNMA funds by Lipper Analytical Services, there are a number of differences in addition to whether -- and at what rate -- they impose sales charges.

Some, such as the Smith Barney, Federated, Vanguard, Benham and Franklin funds, are over 90 percent invested in Ginnie Maes. Others also invest significantly in Treasuries, which recently have been outperformed by Ginnie Maes, or other

government-related, mortgage-backed securities.

A few have annual operating expenses of 0.50 percent or less -- Vanguard is lowest at 0.34 percent -- while others exceed 1 percent, eating into yield investors could otherwise receive.

But perhaps the most significant difference lies in their policies on maximizing dividends.

As the table of the last five years' leading performers indicates, some distributed income during the latest 12 months at a rate of around 8.5 percent. Others, such as Franklin and Putnam, paid dividends at a higher rate.

Those that paid at the lower rate were concentrated in Ginnie Maes whose average interest rates were close to current market levels or lower. (It's now around 8.5 percent, and some hold Ginnie Maes with rates as low as 7 percent.) Their strategy: to minimize holdings of Ginnie Maes likely to be prepaid. That approach paid off during recent months when prepayment rates rose as interest rates fell.

Others, with portfolios tilted toward interest rates as high as 15 percent, accepted the risk and are likely to fare better when interest rates rise again. With an average rate of 10.77 percent at the end of March, Franklin's portfolio manager, Jack Lemein, says, however, he has enough high coupons. He's putting new cash into 8.5 percent Ginnie Maes.

If you, too, are interested in a GNMA fund, look for one that not only has consistently been among the leading performers but that also appears well-positioned for the period ahead.

If you agree with those who believe that long-term interest rates are likely to fall, you'll want a fund that doesn't try to pay the highest dividends.

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