A crucial thing to know about GNMAs and other mortgage-backed bonds is that they behave somewhat differently than other bonds. When interest rates go down, people tend to prepay their mortgages via refinancing. This results in a portion of the principal of GNMAs being repaid prior to maturity, thereby forcing the fund to reinvest its cash in new lower-yielding bonds.
What this means is that, relative to the price appreciation that other bond funds experience during periods of falling interest rates, the price appreciation of GNMA funds is limited.
Note that this does not mean that the price of a GNMA fund will go down when rates go down. It simply means that the price will probably not go up at the rate at which the prices of other similar-duration bond funds would go up. In other words, GNMAs have the same downside as other bonds, but their upside is limited. In exchange for this limited upside, GNMAs have higher yields than Treasury bonds of a similar duration.
Generally speaking, when it comes to bonds, the market is quite efficient — meaning that, over the long term, most bonds earn returns that are commensurate with their level of risk.
While GNMAs operate a bit differently than other bonds, I think they can be a reasonable thing to hold in a portfolio. That said, I cannot think of a single financial goal for which GNMAs would be better suited than other types of bonds.
No new explicit government guarantees came from this action and conservatorship is typically a temporary arrangement. As existing mortgages are paid off prior to the expiration of the loan, the holders of mortgage-backed securities get this principal back and the Fund has to invest in new mortgages at lower rates, potentially decreasing yields.
Rising interest rates pose another risk. When rates rise, prepayments may slow causing duration and interest rate sensitivity to increase which may result in price declines. Given that the Federal Reserve did loosen monetary policy three times in after a tightening trend, the immediate environment seems favorable for mortgage-backed bonds, but for how long? With rates still within the context of historic lows, preparing for an upward trend is certainly worth considering.
As evidenced by the chart to the right, GNMA securities have historically outperformed Treasuries during periods of rising interest rates. Treasuries over the past decade. There is no guarantee that GNMAs will continue to outperform in the future, especially in a volatile yield environment.
Treasuries is state tax-free. Looking at the last four periods of rising rates, GNMAs actually performed quite well in a number of cases. Treasuries, despite the fact that U. Treasuries provided better performance than one might expect, and demonstrated positive performance for all three periods:.
The combination of historic performance, government backing and current income makes GNMA securities an asset class investors may wish to consider as part of their diversified portfolio.
The Barclays U. Aggregate Bond Index is composed of U. Treasury Bond Index is a component of the Barclays U. Aggregate Index. Performance shown is historical. The chart is for illustrative purposes only and not indicative of any Voya fund. Index performance does not reflect any management fees or expenses associated with investing in mutual funds.
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