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Looking for Yield? Try Agency Bonds

ATLANTA ( TheStreet) -- Chad Stephens, manager of the RidgeWorth U.S. Government Securities Ultra-Short Bond Fund (SIGVX), says bonds issued by government-backed agencies are a safe place for investors seeking extra yield.

The $1.3 billion fund, which garners five stars from Morningstar (MORN) has returned 3.7% during the past year, outperforming the 2.3% gain of the Barclays Capital Aggregate Bond Index. More than 90% of the fund is invested in bonds tied to mortgages, according to Morningstar.

Welcome to's Fund Manager Five Spot, where America's top mutual fund managers share their investment views in five fast and furious questions.

Why are agency bonds good to hold now?

Stephens: They offer attractive yields versus Treasuries, but we also get the agency guarantee. We don't take any credit risk, so it's not a matter of if we are going to get paid back. It's just a question of the timing of the security's cash flows.

There's a lot of worry over the entities themselves. What's going to happen to Fannie Mae (FNM) and Freddie Mac (FRE)?

Stephens: We will definitely see a restructuring of the entities, whether it goes to a Ginnie Mae-type structure, completely under the government, or if its privatized again under different rules. I'm not sure. And there is also a proposal to do it as a co-op-type thing. I think any of those could work, but they all have their downsides.

Who are some of the big buyers of agency bonds right now?

Stephens:The biggest buyers at the short end of the mortgage market are the commercial banks. They are flush with cash right now. They are not lending. So they have to put that capital to work. The mortgage market is a good place for them to earn yield and have liquidity so they can sell these securities when loan demand picks up.

Where do you foresee rates at the end of the year?

Stephens:We don't expect the Federal Reserve to raise interest rates until the third or fourth quarter. I do think we will see a Fed hike by the end of the year.

What happens when the Fed stops buying mortgage backed securities?

Stephens: Everyone has been very concerned that spreads would widen and mortgage rates would go up when the Fed ended their program. However, in February, Fannie Mae and Freddie Mac announced that they were going to start buying all the 120-day-plus delinquencies in their pools. This equates to Fannie and Freddie taking out $190 billion of securities from the market while simultaneously putting $190 billion in cash into investors' hands. This, in effect, extends the Fed's buying program for several months and should be very supportive to spreads and mortgage rates.

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