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I want to know what could make the underlying share price of a Ginnie Mae Fund go down.

The two reasons I know are:

1) People start paying back their mortgages ahead of time
2) Interest rates on mortgages start to climb.

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https://personal.vanguard.com/us/funds/snapshot?FundId=0036&Fund...

An investment in the fund could lose money over short or even long periods. You should expect the fundís share price and total return to fluctuate within a wide range, like the fluctuations of the overall bond market. The fundís performance could be hurt by:

Prepayment risk: The chance that during periods of falling interest rates, homeowners will refinance their mortgages before their maturity dates, resulting in prepayment of mortgage securities held by the fund. The fund would then lose potential price appreciation and would be forced to reinvest the unanticipated proceeds at lower interest rates, resulting in a decline in the fundís income. Prepayment risk is high for the fund.

Income risk: The chance that the fundís income will decline because of falling interest rates.

Interest rate risk: The chance that bond prices overall will decline because of rising interest rates. In addition, when interest rates decline, GNMA prices typically do not rise as much as the prices of comparable bonds. This is because the market tends to discount GNMA prices for prepayment risk when interest rates decline. Interest rate risk should be moderate for the fund.

Manager risk: The chance that poor security selection or focus on securities in a particular sector, category, or group of companies will cause the fund to underperform relevant benchmarks or other funds with a similar investment objective.

The two reasons you stated actually have an inverse relationship. Fund price would go down based on widening credit spreads on the bonds and the interest rate yield curve. For interest rates, it has more to do with the shape of the curve versus rates themselves. But to simplify things, a sharp increase in the 10 year point in the curve would have a direct adverse impact on the NAV of the assets in the fund.

When people start to preay their mortgages, the action is generally consistent with a decrease in interest rates, which raises the NAV of the assets in the fund because the yield on the unpaid principal balance of the remaining mortgages is high relative to the market. People generally don't prepay their mortgages as interest rates are rising for obvious reasons. The only way the fund would suffer from a higher prepay speed is the rare situation where the fund paid a large premium to acquire a bond in the secondary market.

This topic is very complex and UMT is right on with the need to manage your expectations. If you really want to blow your mind google the term "negative convexity in mortgage bonds".

jamesboy said:   This topic is very complex and UMT is right on with the need to manage your expectations. If you really want to blow your mind google the term "negative convexity in mortgage bonds".

Thanks but all I did was copy and paste in the text from the Vanguard GNMA bond fund (which I linked to in my reply).

Right now there at lots of people who would like to refi/prepay but can't because they're underwater. If the various federal programs eventually start making these refis possible, it'll hit GNMA for sure.

The Wall Street Journal has recently published an article or editorial asserting that banks are artificially making new mortgages and refinancing difficult (by only working with top credit tiers, who generally do not need to refinance)
1) to improve current year financials by holding on to assets in a time where charging people more and more fees is difficult
2) to reduce exposure to litigation and adverse regulatory rulings.

As an aside, does anyone know of any analysts ratings (LOOKING FORWARD) rather than looking past for these GNMA funds. If I cant figure it out, at least I could average what the analysts expectations are.

Eng8492 said:   As an aside, does anyone know of any analysts ratings (LOOKING FORWARD) rather than looking past for these GNMA funds. If I cant figure it out, at least I could average what the analysts expectations are.
It's kind of pointless without some visibility on interest rates. There's no telling how many more QEs we can tolerate. Rates will rise...eventually...maybe.

Personally I wouldn't be investing in any sort of fixed income fund in the current interest rate environment. JMHO. If you want fixed income, now is a good time to buy individual bonds that you plan to hold to maturity.

crhptic said:   Personally I wouldn't be investing in any sort of fixed income fund in the current interest rate environment. JMHO. If you want fixed income, now is a good time to buy individual bonds that you plan to hold to maturity.

The key word is personally. You wont find a bond fund that is less risky yet pays upwards of 2.5 pct. Capital is flying out of stocks, if you have a suggestion for a fund let us know

I'm not clear on what your investment objectives are.

If you want something with zero interest rate risk, buy individual bonds. This fund isn't the answer.
If you want something with a high return, this fund isn't the answer either.
If you think you have found something with a higher return than you'd expect for the risk profile, then generally my experience is that you haven't fully understood the risks. The market is fairly good at pricing risk and return.

One interesting aspect of mortgage bonds is that they tend to suffer (relative to bonds without an embedded option to prepay) in both rising and falling interest rate environments.

You are familiar with the risk that as rates drop, borrowers will refinance and return principal to the bondholders which must be reinvested at prevailing lower rates. This caps price gains in a rally - meaning that as rates drop and prices increase, mortgages will increase in price less and less relative to say, Treasuries, because the length of the cash flows is shortening.

The flip side is that when rates go up, refinance activity will drop and life of the bond will extend (ie, the duration of the bond will increase). What this means practically is that just as price increases are capped in a rally, price losses are magnified in a sell-off. This is because bondholders must accept a lower interest rate cash stream for an increasingly long period of time, when of course they would rather be returned principal via refinances and reinvest at higher prevailing rates. The problem is that nobody refinances as rates rise, so investors in MBS will pay less and less to lock their cash up at a lower rates for longer and longer periods of time.

The plus side to Agency (FNMA,GNMA) MBS is that there is basically no CREDIT risk. Look at the risks on the Vanguard page - usually credit risk with respect to bonds is front and center but it is not even mentioned. Because Principal and Interest are guaranteed by the US Govt, this effectively removes MBS credit risk (or the risk that you will not be returned principal). God bless the USA right.



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