The REIT (NYSE:NLY) Annaly Mortgage invests in Collateralized Mortgage bonds issued by Fannie Mae, Freddie Mac, and Ginnie Mae. Ginnie Mae supposedly carries a Federal guarantee (which has never been tested) the others do not.
The 17% dividend yield can be partly income and partly a return of your own capital when people holding these loans refinance with another lender at a lower rate. Assume the interest only portion of this portfolio will soon yield no more than 5%, minus cost of defaults. The other 11% is either the return of your capital, or it's a return that will soon go away. Annaly kindly does not break this information out for you, although they will at tax time in your 1099.
Annaly further increases the apparent return and the actual risk by buying bonds worth 150% of their capital. A leveraged investment in home mortgages.
Vanguard has a mutual fund, (VFIIX), which makes un-leveraged investments in the same securities the Annaly Mortgage REIT uses borrowed money to purchase. Vanguard issued the following warning:
biz.yahoo.com
Vanguard tells bond fund investors to do homework
Tuesday October 8, 3:41 pm ET -- By Cal Mankowski
NEW YORK, Oct 8 (Reuters) - The Vanguard GNMA bond fund (Nasdaq:VFIIX - News) is drawing loads of new cash this year from investors -- but the Vanguard Group is not exactly cheering.
"It's absurd," Ian MacKinnon, managing director of the Vanguard Fixed Income Group said at a news briefing on Tuesday, referring to the money pouring into the GNMA Fund. "We want to make sure that everybody who invests in that fund knows what they're investing in."
MacKinnon is concerned that some investors may not be aware that record refinancing of home mortgages by consumers is likely to lower future yields.
Vanguard has been sending letters to customers and posting notices on its Web site pointing out some of the peculiarities of GNMA funds. Such funds invest in mortgage-backed securities issued by the Government National Mortgage Association, an agency of the U.S. government. GNMA guarantees timely payment of interest and principal on the securities, each of which represents a pool of individual mortgage loans.
But while the returns on the Vanguard GNMA Fund and others like it have looked juicy, especially compared with in-the-red stock fund returns, Vanguard is concerned that many investors are overlooking the impact of borrowers prepaying their loans.
Consumers are refinancing at a record rate to take advantage of the lowest interest rates in 40 years.
The Securities and Exchange Commission requires fund companies to calculate yield on such funds by taking the last 30 days worth of income, annualizing it, and then after adjustments dividing by the net asset value.
"On the Ginnie Mae the last 30 days worth of income is not what the next 30 days or the next 30 days after that is going to be," MacKinnon said.
The yield is actually "illusory" because of the refinancing, he added.
According to the Vanguard Web site, the current yield on the "Investor" class shares of the fund is 4.94 percent. The average annual total return for 10 years, calculated as of Sept. 30, 2002, is 7.17 percent.
In the last 10 calendar years, there was one year, 1999, when the return was less than 1 percent, and it posted a negative return of nearly 1 percent in 1994.
The Vanguard GNMA Fund has been extremely popular with investors at a time when stock funds are struggling. With about $26.3 billion in assets, the GNMA Fund generated net sales of $906 million in August and $6.08 billion through the first eight months of 2002, according to to research firm Financial Research Corp.
In terms of net sales, the fund is runner-up in both time periods to the PIMCO Total Return Fund (Nasdaq:PTTAX - News), run by well- known bond fund manager Bill Gross.
In fact PIMCO Total Return Fund has recently knocked the Vanguard 500 Index Fund (Nasdaq:VFINX - News) from its perch as the largest U.S. mutual fund. At the end of September, assets in the PIMCO fund had grown to $64.6 billion, while a sagging stock market reduced the Vanguard 500 to $62.8 billion. The 500 fund, which invests in the stocks in the Standard & Poor's 500 index, had around $110 billion in assets at its peak.
GNMA funds are not the only bond funds that could surprise investors who have not done the research. The return on a bond fund is a function of both the yield and any change in the price.
McKinnon said a rise of 2 percentage points in interest rates could be expected to result in a negative total return of 12.5 percent over a 12-month period for a 10-year Treasury bond. That is because bond yields and bond prices move in opposite directions.
A recent survey of investors sponsored by Vanguard and Money magazine found that nearly 70 percent of respondents did not understand the inverse relationship between bond prices and interest rates. |
