Are GNMAs Solid Investments at Today’s Rates?

With employment slow to rebound, the U.S. Federal Reserve Board (the Fed) probably won’t rush to raise interest rates anytime soon, and that could bode well for Government National Mortgage Association securities (GNMAs).

GNMAs are mortgage-backed securities, meaning securities that hold portfolios of mortgages. They are issued by the U.S. Department of Housing and Urban Development (HUD) and are backed by the full faith and credit of the U.S. government. This guarantee is limited to covering the timely principal and interest payments of the loans underlying the security.

The prices of GNMAs, and therefore the value of a fund that holds them, rise and fall as interest rates move. When interest rates fall, people with mortgages usually refinance at lower rates. As they do, more money is returned to the GNMA pool, and GNMA fund managers are forced to reinvest at prevailing lower rates.

On the other hand, when interest rates rise, GNMAs may also decline in value because they hold pools of mortgages purchased at lower interest rates, and people who took out those mortgages have no incentive to prepay them because interest rates are higher.

Therefore GNMAs typically do best when interest rates are stable. And that’s the environment we’re likely in today. Pundits believe that before considering an increase in rates, the Fed will need to see much stronger labor markets and at least some indication of higher inflation. This seems unlikely at the moment.

So our current rate environment may well encourage investors to look more closely at GNMAs.

It can be hard to maintain a bond component to your portfolio when the stock market is performing relatively well, if erratically. But remember, diversification into bonds, including GNMAs, represents one of the best remedies for managing assets during a time of stock market volatility.