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Ginnie Mae yields are a bit plumper than Treasuries

What good are GNMA funds? I love this question! I wish I could take this query and fill in a different fund group each week: What good are REIT funds? What good are precious metals funds? What good are international bond funds? (You get the idea ...) But this was about GNMA funds only, so I promise to limit my comments.

Before I address the pros and cons of GNMA (also known as Ginnie Mae) funds, I thought I'd spend a little time on definitions. What exactly is a GNMA fund anyway?

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A GNMA fund invests the majority of its assets in pools of mortgage securities backed by the Government National Mortgage Association.

The key thing to understand about GNMA mortgages is that, like Treasuries, they are supported by the full faith and credit of the U.S. government.

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Slightly safer

From a credit-quality perspective, this makes GNMA mortgages slightly safer than mortgages from Fannie Mae (FNM) or Freddie Mac (FRE), which are not backed by the full credit of the U.S. government. (Although in reality, Fannie- and Freddie-backed securities are generally considered to be quite safe.)

Because of their ties to the U.S. government, GNMA funds are classified in the intermediate-term government category.

Thus, their category peers include funds that invest exclusively in U.S. Treasuries, as well as funds that invest in a variety of government and government-backed securities, including Treasuries and mortgages.

Now we can turn to the question about the worth of GNMA funds. What good are these things?

Well, GNMA funds are appealing to some investors because their yields tend to be a bit plumper than those of Treasury-focused intermediate-term government funds.

Moreover, funds that focus exclusively on GNMA securities are often somewhat less volatile than Treasury-only funds. Thus, yield-focused investors who are uncomfortable with a lot of volatility might consider a GNMA offering.

Some drawbacks

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Of course, there are also some drawbacks to GNMA offerings. True, GNMA funds aren't as volatile, but that means they're also likely to get less upside pop when interest rates are falling and Treasuries are rallying hard.

Falling interest rates can open up mortgage funds to the problem of prepayments. When interest rates tumble, mortgage owners are more likely to refinance (something many of you have probably done in the past year).

When mortgages are paid back early, the remaining principal is returned and the bondholder is forced to reinvest the capital at the now-lower interest rate - which can trim a fund's payout.

Finally, GNMA funds may offer a decent yield relative to Treasury-focused, intermediate-term government funds, but GNMA funds still can't offer the yields that intermediate-term, corporate-focused funds can.

Of course, corporate bonds always carry more credit risk than GNMA or other government funds do, but more aggressive bond investors may not mind this additional credit risk in return for a fatter yield.

Certainly, though, for those who want a government-focused fund, GNMA offerings are worth considering.


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