Securities based on adjustable rate mortgages, or ARMs, have rebounded this year, but they're still not quite attractive enough for T. Rowe Price Associates Inc.
The Baltimore-based mutual fund company last week renamed its Adjustable-Rate U.S. Government Fund and broadened its investment objectives to allow for a relatively smaller amount of ARM securities.
The $112 million fund is now called the Short-Term Government Fund. And true to its name, at least 65 percent of its assets will be invested in a broader array of government agency notes, bonds and both fixed and adjustable rate mortgages, as opposed to at least 65 percent invested in ARM securities before. As much as 35 percent of the assets can continue to be invested in non-government securities, such as corporate notes and bonds.
"I think that what we have come to agree on is that an adjustable rate fund . . . is too restrictive," said Peter Van Dyke, president of the fund, and a managing director at Price. "And that particular market is more volatile, not from an interest rate sensitivity standpoint but from a supply and demand standpoint, than we thought it would be."
The lack of adequate supply means that it's difficult to count on prices for the securities from one day to the next, or even from one dealer to the next, Mr. Van Dyke explained.
Certainly the direction of interest rates hasn't helped. The sharp rise in short-term rates last year dealt a blow to investors in ARMs. That's because the typical ARM has a cap -- usually 2 percentage points -- above which the homeowner's mortgage cannot rise in any one year. Since the Federal Reserve boosted short-term rates by three percentage points in the year ended Feb. 1, most ARMs couldn't keep up.
Nationwide, ARM funds lost half of their assets during 1994, falling to about $9 billion. Price's fund had more than $600 million in assets at the start of 1993, but by the end of last year it had declined to $112 million.
Ironically, just as the company has chosen to rely less on ARMs, the securities have staged a comeback, based on the diminished fear of higher rates. While the Price fund had a negative total return last year of 0.63 percent, according to Mr. Van Dyke, so far this year it's up almost 3 percent.
"Some people felt that we were abandoning this type of investment at just the wrong time, and to an extent that's true. But we'll still invest in them," Mr. Van Dyke added, it just won't have to be 65 percent or more of assets.