Fixed-income investors who flocked to mortgage securities in search of higher yields may see their returns suffer if the recent dip in interest rates leads to a new wave of mortgage refinancings, as many analysts expect.
Mutual funds that invest in government-backed mortgage bonds have posted a total return -- interest plus price appreciation -- of 6.1 percent this year. That's "still solid -- although their performance has slipped a bit in recent months," said Morningstar Inc. analyst Scott Berry.
But when interest rates tumbled last week to lows not seen since the early 1960s, lenders and investors were bracing for a new wave of mortgage refinancing that was expected to push total mortgage volume to the level of last year's record of $2.2 trillion, or even higher.
Even though yields on Treasury securities had rebounded a bit by late Friday, a key index of home mortgage rates ended the week at 6.22 percent.
It's uncertain how long rates will remain at such levels. Interest rates have been highly volatile since last fall, and many analysts were saying last week that yields had fallen so low that investors would be induced to pull money out of the bond market and invest it in stocks instead. That could fuel further rises in Treasury yields.
But if mortgage rates remain depressed long enough for home buyers to refinance -- some for the second or third time in a year -- mutual funds that hold mortgage bonds probably would see their returns slip.
Government National Mortgage Association securities -- known as Ginnie Maes -- that carry 7 percent yields are being refinanced at an annual rate of at least 40 percent, bond fund managers said. That means older, high-yielding securities are replaced with newer, lower-yielding issues, pushing the yields on mortgage-bond funds to 5 percent or less.
Even that's not such a bad yield these days, said Bill Powers, a portfolio manager and managing director at Pacific Investment Management Co. in Newport Beach, Calif. A fund with that much turnover in its portfolio probably is best compared to a two-year Treasury bill, Powers said, and two-year Treasuries are paying about 2.2 percent.
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