High Ginnie Mae (GNMA) Yields

Last Updated Dec 12, 2010 11:25 PM EST

GNMA Bonds are backed by the US Government and, historically, have paid a higher yield than other US Government bonds. That extra yield went away early this year prompting me to find out what's going on with GNMA yields. Now the extra yields are back, but should you bite?

GNMAs are mortgage backed securities that are packaged and guaranteed by the Government National Mortgage Association. Unlike Fannie Mae and Freddie Mac, the Ginnie Mae has always been a government entity, with essentially no default risk.

Recently, yields were as follows on the following intermediate bond funds.
  • 1.61% - Vanguard Intermediate Term Treasury (VFITX)
  • 2.58% - Vanguard Total Bond Index (VBMFX)
  • 3.20% - Vanguard GNMA (VFIJX)
No free lunch
With the GNMA bond yielding twice the Treasury bond, it might appear that the GNMA is superior. And when you consider the average duration (a measure of interest rate risk) of the GNMA bond is 1.9 years while the Treasury is 5.3 years, GNMAs look especially attractive. But as I've noted before, there is no free lunch here.

GNMA durations are estimates only because the payoff dates of the underlying mortgages are uncertain, rather than being fixed as is the case with many other bonds. When people refinance or have their houses foreclosed upon, the mortgages get paid off early. Thus, the actual durations can vary greatly from the estimates. Increasing rates might stop the refinance wagon, but could also actually speed up the repayments if it causes an increase in foreclosures.

Is the higher yield worth the risk?
My colleague, Larry Swedroe, correctly observes that the total return is more important than the yield. According to Wellington Management, the manager of the GNMA bond fund, the GNMA has yielded an extra 0.5% over the equivalent duration Treasury bonds. This extra yield is compensation for two factors:
  • Less upside potential from GNMAs when interest rates decline, as people will refinance their mortgages.
  • Treasuries are State tax-deductable while GNMAs are not. Thus, some of the extra GNMA yield is taken by taxes.
My take on GNMAs
I do have to disagree with Larry Swedroe's analysis that GNMAs haven't given extra yield. Markets are generally efficient and avoiding GNMAs is yet another misguided attempt to be smarter than the market. I own and recommend GNMAs, as I do Treasuries and corporate investment grade bond funds. The Vanguard Total Bond Fund owns all of these with dirt low costs and high liquidity.

My take on fixed income - even better than bonds
While I do own all investment grade securities, I prefer the free lunch of certain certificates of deposits (CDs). The potential of a bond bubble is real and all intermediate bonds and bond funds will get hit pretty hard when interest rates rise. Certain CDs give higher yields than even GNMAs, yet provide downside protection from higher rates. In my opinion, they are better than bonds.

These CDs are best bought directly from the institution, which cuts out all advisors who charge either commissions or assets under management. That's precisely why they do exist.

More on MoneyWatch
What's Going On With Ginnie Mae (GNMA) Bond Yields?
The Bond Party is Over
Muni Bond Costs - The Whole Truth
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    Allan S. Roth is the founder of Wealth Logic, an hourly based financial planning and investment advisory firm that advises clients with portfolios ranging from $10,000 to over $50 million. The author of How a Second Grader Beats Wall Street, Roth teaches investments and behavioral finance at the University of Denver and is a frequent speaker. He is required by law to note that his columns are not meant as specific investment advice, since any advice of that sort would need to take into account such things as each reader's willingness and need to take risk. His columns will specifically avoid the foolishness of predicting the next hot stock or what the stock market will do next month.

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