Vanguard GNMA?

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paul e
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Vanguard GNMA?

Post by paul e »

How do you feel about the GNMA fund today as a bond fund investment?

This asset is in trust and is used to throw off income to my mother and is currently in a Ma Muni Bond fund. In her tax bracket which is 25 or 28%, I think the GNMA fund looks like a good bet for more income, and has good annual return as well. As for risk, Vanguard rates it a '2', whereas the Mass Muni fund was rated a '3'.

Thoughts?
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Post by jginseattle »

Make sure you understand the risks associated with that fund and don't just look at the current yield

Take a look here...

http://www.bogleheads.org/wiki/Mortgage ... Securities

Also search the forum for the many discussions on this fund.
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Post by nisiprius »

I assume you're referring to Vanguard Massachusetts Tax-Exempt Fund (VMATX). The reason why Vanguard puts this in risk category 3 is almost certainly because it's a long-term bond fund, and therefore interest rate ranges will create larger fluctuations in its market value than other funds.

However, if it is being used to "throw off income," fluctuations in market value may not be a terribly big concern.

As for "more income," that's not crystal-clear. I'm seeing 3.24% SEC yield for the GNMA fund, VFIIX, taxable, and 2.49% for VMATX, tax-exempt. In a 28% tax bracket, 3.24% taxable = 2.33%, seems to me it's about the same. I'm not too clear on this and I might have screwed up, though. Why do you think the GNMA fund will be paying her more income?
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paul e
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Post by paul e »

nisiprius wrote:I assume you're referring to Vanguard Massachusetts Tax-Exempt Fund (VMATX). The reason why Vanguard puts this in risk category 3 is almost certainly because it's a long-term bond fund, and therefore interest rate ranges will create larger fluctuations in its market value than other funds.

However, if it is being used to "throw off income," fluctuations in market value may not be a terribly big concern.

As for "more income," that's not crystal-clear. I'm seeing 3.24% SEC yield for the GNMA fund, VFIIX, taxable, and 2.49% for VMATX, tax-exempt. In a 28% tax bracket, 3.24% taxable = 2.33%, seems to me it's about the same. I'm not too clear on this and I might have screwed up, though. Why do you think the GNMA fund will be paying her more income?
Youre right.. I must have been looking at the wrong line! Mom's in Ct now, and unfortunately, there are no Vanguard Ct muni bond funds. I guess maybe Ill stay the course and hang on to the VMATX.. She'll at least get federal deductibility. I could also use VWITX (int tax exempt bond fund) but I dont see any real advantage other than the slightly shorter duration. Not alot of great choices... Shes top loaded with stocks in terms of a proper asset allocation ratio for someone her age (89), so I dont dare go that route.

thanks.

>>Make sure you understand the risks associated with that fund and don't just look at the current yield <<

Yea, I checked out that bogleheads wiki, and its enough to scare one a bit.. Mortgage Backed Securities taste a litte sour after the big market crash in 08. Thanks for reminding me of the risks...
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Post by Eureka »

paul e wrote:Mortgage Backed Securities taste a litte sour after the big market crash in 08. Thanks for reminding me of the risks...
I have detected a bias against the GNMA Fund here since I became a member in 2007. I believe Larry Swedroe and his admirers are largely responsible for this.

I have read all the posts, and I understand the reasoning. Someday, all these risks may come home to roost. However, in the interest of historical accuracy, I will list calendar-year total, pre-tax returns for the past few years for VFIIX. This encompasses the financial meltdown:

2007: 7.01 percent

2008: 7.22 percent

2009: 5.29 percent

2010: 6.95 percent

2011 YTD: 6.42 percent

Past performance is no guarantee of future results, and bond funds in general have enjoyed 30 years of declining or steady interest rates. But, this fund survived the "Great Recession" quite well. GNMA bonds have ALWAYS had an explicit full-faith guarantee from the U.S. government for timely payment of principal and interest, unlike Freddie and Fannie securities.
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Post by deerhunter »

Agree with Eureka. I have been heavily invested in GNMA's since I dumped the bulk of my stock funds in the year 2000. For someone my age who seeks safety along with decent returns, they have done very well.
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Post by Paul@ »

I also agree with Eureka.

I get the sense that there is perhaps some overstated bias to GNMA risks vs. other bond fund choices. I really don't see much difference at all when I look at historical performances. There is essentially no credit risk, and the fund's managed short duration keeps the interest rate/prepayment risks well within reason. GNMA's history shows that it has in fact stacked up quite well vs. other bond funds, over time. I have GNMA as just one part of my tax-sheltered bond allocation and am pleased with the income it throws off.
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Post by theduke »

I too like GNMA's. Have been invested in them since 1996. I haven't been disappointed yet, but they are just a portion of my fixed income.
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paul e
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Post by paul e »

paul e wrote:
nisiprius wrote:I assume you're referring to Vanguard Massachusetts Tax-Exempt Fund (VMATX). The reason why Vanguard puts this in risk category 3 is almost certainly because it's a long-term bond fund, and therefore interest rate ranges will create larger fluctuations in its market value than other funds.

However, if it is being used to "throw off income," fluctuations in market value may not be a terribly big concern.

As for "more income," that's not crystal-clear. I'm seeing 3.24% SEC yield for the GNMA fund, VFIIX, taxable, and 2.49% for VMATX, tax-exempt. In a 28% tax bracket, 3.24% taxable = 2.33%, seems to me it's about the same. I'm not too clear on this and I might have screwed up, though. Why do you think the GNMA fund will be paying her more income?
Youre right.. I must have been looking at the wrong line!

thanks.

>>Make sure you understand the risks associated with that fund and don't just look at the current yield <<

Can you expound upon the risks a little? ..
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Post by jginseattle »

I'm not "against" GNMAs. I've owned them and my mom currently owns them. But they do have some unique features and I think it's important that investors have an understanding of how they work. Look at the information and then decide for yourself.
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Post by etarini »

paul e wrote:I could also use VWITX (int tax exempt bond fund) but I dont see any real advantage other than the slightly shorter duration.
Don't forget the diversification that a national muni fund gives you compared to a single-state fund.

I live in Massachusetts, and have been holding VWIUX ( Vanguard Int-Term Tax-Exempt Admiral), but all my new bond investment has gone into (thanks, Fred Flintstone) Baird Int-Term Tax-Exempt (BMBIX). The latter has higher quality bonds, but a slightly lower return. Minimum investment for their lower-cost institutional shares is $10,000 if you buy it through Vanguard Brokerage.

Check out the Morningstar style boxes and the current returns for the 3 funds.

Eric
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Post by zaplunken »

GNMA fund is great but now is a bad time to buy it. NAV for all bond funds are very high, GNMA has hit a few new record highs in the past several months. At this point you are paying top dollar plus for the fund and as rates eventually rise for mortgages you'll have a capital loss though the dividend will go up. The best time to buy GNMA is when the nav is in the low $10 or below range. Costs matter and the cost for bond funds are terrible now.
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Post by Eureka »

zaplunken wrote:GNMA fund is great but now is a bad time to buy it. NAV for all bond funds are very high, GNMA has hit a few new record highs in the past several months. At this point you are paying top dollar plus for the fund and as rates eventually rise for mortgages you'll have a capital loss though the dividend will go up. The best time to buy GNMA is when the nav is in the low $10 or below range. Costs matter and the cost for bond funds are terrible now.
This is a good point. The traditional NAV range for this fund is $9.50 to $10.50. It's been way above that range for many, many months.
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Post by expat »

I prefer Vanguard Intermediate-Term Treasury fund. Higher total return, no credit risk, inversely correlated to stock market.
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Post by Kevin M »

expat wrote:I prefer Vanguard Intermediate-Term Treasury fund. Higher total return, no credit risk, inversely correlated to stock market.
No one knows what the total return will be going forward. The SEC yield currently is only 0.92%, which does not bode well for a high total return going forward. With an average duration of 5.3 years, your upside appreciation is limited to about 5% if intermediate treasury rates drop to 0%, and your downside is a whole lot bigger than that when rates increase.

As already pointed out by someone else, there is no credit risk with GNMAs. The SEC yield currently is 3.31% and average duration is 2.1 years, although I realize that due to negative convexity this has less meaning than for other types of bonds. Also lots of downside if rates increase, but that's true for all bonds at these low rates.

I don't own either. I prefer investment grade, munis and intermediate-term CDs with small early withdrawal penalties. if I had to pick one, I'd pick CDs; no credit risk (assuming FDIC insured), higher yields than treasuries (about 2%), and no interest rate risk other than the small early withdrawal penalty.

If I had to pick between int-term treasuries and GNMA, I'd go with GNMA.

Kevin
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Taylor Larimore
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GNMA bonds

Post by Taylor Larimore »

Eureka:

Good post. Thank you.
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expat
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Post by expat »

The SEC yield currently is 3.31%
With GNMAs, people tend to focus on the yield, but, for me, it's the total return that matters.
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Post by Kevin M »

expat wrote:
The SEC yield currently is 3.31%
With GNMAs, people tend to focus on the yield, but, for me, it's the total return that matters.
Agreed, but again, what's your basis for expecting higher total returns from intermediate-term treasuries than GNMAs going forward? I'd be interested in your response to the rest of my post, rather than just the one isolated statement you clipped.

Kevin
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Post by jimkinny »

From Vanguard's website, there is a prepayment risk.

The weight of the federal executive branch backs the idea of supporting prepayment of mortgages by homeowners via refinancing. So, you are betting against the executive branch by betting on GNMAs. Who knows the outcome, just that there is a lot of interest in this.

The Federal Reserve's goal is now to push down long term interest rates further. So, you are betting against the Fed. Reserve.

I do not know how the fact of 20% of all current mortgages being underwater affects GNMAs. Does mortgage insurance cover the entire loan if the home owner defaults? regardless, some of these loans will get paid off early via default, if not most. If the housing market declines further, more will default.

Larry Swedroe, in a recent blog at Moneywatch, likened GNMAs to a shiny apple. We are attracted to the shine, aka yield. I will accept that historically GNMAs have been an anomaly in that the pricing does not take into account entirely the convexity. I certainly do not have the data but accept this to be true.

I also tend to think that time is not on GNMAs side, long term. Since 2008, the fed has been guaranteeing most new mortgages. Maybe this trend will go down in the future.

What would have happened without the fed backup in 2008? massive defaults?

So, what's to like?

Nisprius wrote (I'm paraphrasing) that maybe we are comfortable with Vanguard's GNMA fund. It is one of Vanguard's oldest and maybe that part of its appeal.

Jim[/code]
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Post by Valuethinker »

jimkinny wrote:From Vanguard's website, there is a prepayment risk.

The weight of the federal executive branch backs the idea of supporting prepayment of mortgages by homeowners via refinancing. So, you are betting against the executive branch by betting on GNMAs. Who knows the outcome, just that there is a lot of interest in this.

The Federal Reserve's goal is now to push down long term interest rates further. So, you are betting against the Fed. Reserve.

I do not know how the fact of 20% of all current mortgages being underwater affects GNMAs. Does mortgage insurance cover the entire loan if the home owner defaults? regardless, some of these loans will get paid off early via default, if not most. If the housing market declines further, more will default.

Larry Swedroe, in a recent blog at Moneywatch, likened GNMAs to a shiny apple. We are attracted to the shine, aka yield. I will accept that historically GNMAs have been an anomaly in that the pricing does not take into account entirely the convexity. I certainly do not have the data but accept this to be true.

I also tend to think that time is not on GNMAs side, long term. Since 2008, the fed has been guaranteeing most new mortgages. Maybe this trend will go down in the future.

What would have happened without the fed backup in 2008? massive defaults?

So, what's to like?

Nisprius wrote (I'm paraphrasing) that maybe we are comfortable with Vanguard's GNMA fund. It is one of Vanguard's oldest and maybe that part of its appeal.

Jim[/code]
Prepayment risk is presumably not of a concern to GNMA holders. Indeed with the fall in housing equity, refis are presumably less likely than historically low interest rates would suggest?

However extension risk is significant. I believe the VG managers are aware of this, and have deliberately chosen GNMAs with relatively short maturities to fight this?
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Post by jimkinny »

Vakuethinker wrote:
"Prepayment risk is presumably not of a concern to GNMA holders. Indeed with the fall in housing equity, refis are presumably less likely than historically low interest rates would suggest?

However extension risk is significant. I believe the VG managers are aware of this, and have deliberately chosen GNMAs with relatively short maturities to fight this".

I was parroting what I thought was known about GNMA risks. Are you writing that prepayment risks are not as much of a concern because of the inability of mortgage holders to refinance because they have less than 20% or so of equity and/or have "negative" equity in the homes? I thought there was a political risk involved in this aspect. I am making no value judgments, just that there was talk in Washington to improve the prospects of homeowners making timely payments with little or less than zero equity in their homes and at higher than current rates.

If I ever knew about extension risk, I had forgotten about it. Thanks for pointing this out. Just another reason to avoid GNMAs.

Jim

I keep screwing up the quote feature so I used quotation marks.
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Post by Valuethinker »

jimkinny wrote:Vakuethinker wrote:
"Prepayment risk is presumably not of a concern to GNMA holders. Indeed with the fall in housing equity, refis are presumably less likely than historically low interest rates would suggest?

However extension risk is significant. I believe the VG managers are aware of this, and have deliberately chosen GNMAs with relatively short maturities to fight this".

I was parroting what I thought was known about GNMA risks. Are you writing that prepayment risks are not as much of a concern because of the inability of mortgage holders to refinance because they have less than 20% or so of equity and/or have "negative" equity in the homes? I thought there was a political risk involved in this aspect. I am making no value judgments, just that there was talk in Washington to improve the prospects of homeowners making timely payments with little or less than zero equity in their homes and at higher than current rates.

If I ever knew about extension risk, I had forgotten about it. Thanks for pointing this out. Just another reason to avoid GNMAs.

Jim

I keep screwing up the quote feature so I used quotation marks.
with square brackets will do it around the words quote and /quote

On prepayment risk:

- normally it gets worse when interest rates fall- borrowers refi

Setting aside future legislative changes, fundamentally if equity drops below 20% it gets hard/ expensive to revalue (technically that is a 'non conforming' mortgage and therefore not GNMA underwritable by law, I believe).

I believe that the average GNMA bond is expected to pay back 90% of its outstanding within 9 years (I saw that in a presentation, fact check it before quoting me). Since the mortgages are 30 years, you can see the extension risk.

This happened more or less in the 70s. Inflation was c. 10% but my parents say were on a mortgage of 5%. Smart people did not repay early.

If interest rates rise, there is considerable extension risk in *any* mortgage backed security. In effect the duration of the fund will move out against you.

*however* by buying ones close to maturity (the mortgages in them are 'old') VG's managers can reduce that risk.

Historically looking at GNMA fund against other US Treasury Bond funds, you have not been rewarded for taking on that risk.
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Re: Vanguard GNMA?

Post by Senin »

Eureka,
Absolutely perfect post!

As another poster stated:
GNMAs have been an anomaly.

They seem to do amazing in all weather. I remember when the refi boom hit. They were suppose to tank. They didn't.

They keep plugging along. 6%. 7%.

I will take it.
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Re: Vanguard GNMA?

Post by Kevin M »

Senin wrote:Eureka,
Absolutely perfect post!

As another poster stated:
GNMAs have been an anomaly.

They seem to do amazing in all weather. I remember when the refi boom hit. They were suppose to tank. They didn't.

They keep plugging along. 6%. 7%.

I will take it.
Senin, with all due respect, to think you will get a 6% or 7% return from a bond fund with a current SEC yield of less than 3% is absurd. Maybe you will get that for a couple of years if rates drop to 0%, but then the party is over. The best estimate of the return over the next four years (the duration of the fund) is the SEC yield, and given the screwy nature of duration for GNMA funds, I'm not sure four years is even the right time frame to use. But the point is that with yields at less than 3%, it is irrational to expect returns of 6% or more.

So, with the current SEC yield at about 2.6%, I wouldn't hold the fund expecting to get much more than that, and would be prepared for much less than that when interest rates finally start to increase. Not predicting anything, just using basic bond math.

Kevin
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Re: Vanguard GNMA?

Post by Eureka »

And keep in mind that my post was seven months ago. Some sort of reckoning is coming when rates normalize. My crystal ball is too cloudy to predict when that will be. I will be very surprised if the total return of the GNMA Fund is 4 percent or more this year. Not shocked, but surprised.
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Re: Vanguard GNMA?

Post by Saphomd »

So if sec yields increase over 3%, GNMA will increase?
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Re: Vanguard GNMA?

Post by dbr »

Saphomd wrote:So if sec yields increase over 3%, GNMA will increase?
No, if the yield increases the market price of the fund falls. The total return could even be negative for awhile.
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Re: Vanguard GNMA?

Post by tibbitts »

The problem with not investing in GNMAs is that you have to invest in something else. Treasuries are now paying substantially less for similar (even if approximate with GNMAs) duration; corporates may not pay you back at all, and at the very least are more likely to temporarily tank during a panic; high-yield is... well, if you don't like corporates, you won't like high-yield; munis are just not that exciting for the majority of people in or near the 0% bracket; CDs are potentially less liquid, have somewhat higher maintenance, and have reinvestment risk; and equities, even the dividend-paying variety, are not bonds, and are arguably somewhat richly priced.

On the other hand, 6-7% is not realistic from a fund paying 2.6%. 2.6% is probably somewhat more realistic, over the fund's admittedly approximate duration.

Paul
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Re: Vanguard GNMA?

Post by Kevin M »

Paul, you are right that CDs are less liquid, and there is a bit more maintenance since you need to open an account somewhere besides Vanguard (to buy non-brokered CDs, which is all I consider currently). Not sure what you mean about reinvestment risk though; you can have your CD interest reinvested in the CD, so you don't have reinvestment risk as with a bond that pays interest.

I much prefer a federally insured 5- to 7-year CD paying 2.25% - 2.5% with an early withdrawal penalty (EWP) of six to twelve months of interest over a bond fund paying a comparable rate. The bond fund has both credit risk and interest rate risk. Other than the EWP, the CD has neither.

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Re: Vanguard GNMA?

Post by tibbitts »

Kevin M wrote:Paul, you are right that CDs are less liquid, and there is a bit more maintenance since you need to open an account somewhere besides Vanguard (to buy non-brokered CDs, which is all I consider currently). Not sure what you mean about reinvestment risk though; you can have your CD interest reinvested in the CD, so you don't have reinvestment risk as with a bond that pays interest.

I much prefer a federally insured 5- to 7-year CD paying 2.25% - 2.5% with an early withdrawal penalty (EWP) of six to twelve months of interest over a bond fund paying a comparable rate. The bond fund has both credit risk and interest rate risk. Other than the EWP, the CD has neither.

Kevin
There is nothing terrible about CDs, but they aren't magic either. There is no more credit risk in GNMA than in a CD. Reinvestment is a somewhat continuous and automatic process with GNMA or any other bond fund, whereas with a CD it's a periodic decision that may or may not come at an opportune time. The difficult thing about buying a ladder of CDs with the idea of possibly redeeming some or all if rates rise is that you have to frequently monitor rates, and decide if/when to redeem. If you make good decisions, you may make out better than a fund; if you make a series of bad decisions, maybe not. But in most cases you probably won't make out dramatically better or worse with CDs, and will have done somewhat more work in the process. Certainly, if circumstances dictate a complete redemption of all your investments soon after a rapid rate rise, you'll be better off in CDs.

Paul
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Re: Vanguard GNMA?

Post by Kevin M »

Paul: True about no credit risk in a GNMA fund or a treasury bond fund, so these particular funds are equal to a federally-insured CD in this respect. Many people invest in TBM, which does have credit risk, so I tend to always mention that federally-insured CDs have no credit risk, but in the context of this thread on GNMA funds, it is not relevant.

Reinvestment in a 7-year CD is automatic for seven years, and if you want, you can just let it roll over when it matures, so also automatic. I see no benefit in a bond fund here.

I don't own a ladder of CDs, because the longer-term CDs with low EWPs pay more on early withdrawal than shorter-term CDs. The shortest-term CD I own is a 4-year Ally raise your rate CD, and mostly I own 5 to 7 year CDs.

I don't think you have to frequently monitor rates in the current environment, since I expect rates to stay low for awhile. Checking on CD rates now and then takes about a minute, and if you pay any attention at all to your bond funds, you'll know when rates have risen because the values of your bond funds will have fallen. I don't find anything about this difficult at all, but maybe others might.

I don't understand your statements about having to make a series of good or bad decisions. Right now you just have to make one decision: move some of your money from a bond fund to a CD. No more decisions necessary as long as rates stay low. If rates rise, then yes, at some point I will have to decide to hold or fold, but that's a decision I'll be very glad to have the opportunity to make, because it will mean I will be ahead of where I would have been in a bond fund.

Yes, it is a bit more work, so not for everyone. If rates rise, you'll be better off in CDs whether or not your circumstances dictate a complete redemption. If rates rise 2%, you will be down 8%-10% in an intermediate-term bond fund (again, GNMA's are strange beasts with variable duration, so maybe they won't respond the same as other bond funds), whether or not you redeem. My CDs will not be down at all, and I'll pay anywhere from 0.3% to 2.5% to do an early withdrawal (depending on the particular CD) and reinvest at the higher rate, so will be getting the same benefit as the higher bond fund rate, but with a much smaller capital loss. The difference may not be "dramatic", but it is meaningful to me.

Many people on this forum say fixed income is for safety, take your risk in equities, etc. CDs are safer than bond funds, because of the limited interest-rate risk. So, comparable yield with less risk; I like that.

Kevin
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