Don't Overlook Ginnie Maes
It's not happening yet, but massive borrowing will inevitably boost long-term interest rates and hammer the market value of Treasury bonds. At the same time, I understand why you like federal guarantees. This presents an unpleasant choice: Hold onto Treasuries that are in peril of losing significant market value, or move to edgier neighborhoods of the bond marketplace. BBB-rated and junk corporate bonds pay unusually high yields now relative to the Treasury. Emerging markets bond funds are having a good run. But I cannot recommend you take more than a token position to junk and foreign bonds if you're managing irreplaceable savings.
||Where to Find Top Yields|
||A Dividend ETF Disappoints|
||Investments That Pay You Every Month|
Ideally, you want something that has the government's backing that pays more than 3.2% for ten years or 4.1% for 30, the current yields on Treasury debt. You can buy a ten-year FDIC-insured CD from Charles Schwab that pays interest monthly but still earn just 3.85%. At that rate you may as well feed an online savings account for 2% or so and wait for CDs to pay better as the economy recovers and banks bid up for deposits.
However, there's one other, often overlooked, U.S. guaranteed alternative, Ginnie Maes. It sounds crazy to praise mortgage-related investments so soon after mortgage derivatives incinerated Wall Street and the world economy, but the Ginnie Mae brand is different.
GNMA, formally known as Government National Mortgage Association, isn't a direct lender or a for-profit financial firm. It is an agency within the U.S. Department of Housing and Urban Development that unlike Fannie Mae and Freddie Mac never was a stockholder-owned corporation whose managers had any incentive to inflate earnings to try to pump the stock price. Ginnie simply stamps Uncle Sam's full faith and credit on pools of conservative privately-issued home loans.
Since the start of what we call the financial meltdown last year, GNMA securities have stood firm. From mid-September through May 20, the popular Vanguard GNMA fund (symbol VFIIX), the category's largest, has returned 6%, to 4% for Vanguard's broad bond market index ETF and even less for some other ostensibly non-mortgage-related investments. Monthly cash distributions are off slightly the last couple of months, but net asset value per share is up from $10.31 to $10.70, quite a leap in this kind of fund over a short an interval.
This isn't due to any unique trading wizardry. Other GNMA funds, such as those from BlackRock and Payden, did as well or better. American Century's and Fidelity's GNMA funds virtually equaled Vanguard. The Dreyfus GNMA fund can invest up to 20% in credit card receivables and non-government-guaranteed mortgage securities, so it's one of the category's laggards. But it still is ahead since Lehman Brothers vanished.
Clearly, this is a superb showing in challenging times. GNMA funds did get some help from the red tape and scarce credit that's made it hard for homeowners to refinance mortgages at lower rates. Refis are a headache for investors in mortgage pools because lower-paying loans replace higher-paying ones.
Your best environment is for rates to hold fairly steady. Rising rates will erode some principal, but even there, you get a break. If mortgage rates climb, and they should if long-term Treasury rates do, many of the 6% loans you find in current GNMA portfolios will stick. They won't refi, but they also won't default. Ginnie isn't a party to questionable adjustable-rate or interest-only or jumbo mortgages. Most of its guarantees are on modest-sized loans under low-risk programs like the Veterans Administration.
I asked a broker for some current quotes on individual GNMA securities. You need $25,000, so here's one area of bonds where I prefer funds with no reservations -- and besides, when rates are rising, funds have a buffer of some older higher-rate pools. The broker said business is slow in individual Ginnies because the strong performance has narrowed the spread between GNMA yields and Treasury yields.
But the mortgages still do pay better. A newly-issued GNMA pool in April was priced to yield an estimated 3.8% on the assumption that half of the loans would be refinanced or paid off in three years. A three-year Treasury, and I know that's not a precise comparison because mortgages are supposed to last 30 years, pays 1.3%. That's still scanty. But 3.8% for a while is good enough for full faith and credit.