Prepayment FactorSo why does a mortgage fund, even one whose balance is entirely in Treasury securities, act differently than a regular bond fund? As you know, if you have a mortgage you can prepay it at any time, and are more likely to do so if interest rates fall. Likewise if interest rates rise, you would be less likely to prepay. Viewed from the perspective of an investor in mortgage-backed securities, that is an option retained by the issuer. As an investor in mortgage-backed securities, you have effectively sold an option in exchange for a higher yield. Your main risk is that interest rates will decline and the rate at which homeowners are prepaying their mortgages will go up, and you will have to reinvest at lower yields. This chart shows how Ginnie Mae and mortgage funds underperformed intermediate Treasury funds during last year's great bull market in bonds.
|Mortgages vs. Treasuries |
Median total return for each mutual fund category, retail funds only
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