GNMA....Sell or hold

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hoops777
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GNMA....Sell or hold

Post by hoops777 »

I bought a large amount of VFIIX about 15 months ago.With reinvested dividends I am back to what I originally invested,so 0 return,0 loss on paper.Unless something drastic happens I will be reinvesting all dividends in my bond funds for the next 7 or 8 years when I retire.Should I get out now and switch to total bond?I also have a good amount in short term corp and Ibonds.Whatever I do I do not want to think about it again.The never ending anguish about bond funds and duration with rising interest rates.....I have grown weary. :D
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Re: GNMA....Sell or hold

Post by Toons »

Do yourself a favor ,ignore the noise and all the drama,don't sell ,keep reinvesting another 10 years :happy
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livesoft
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Re: GNMA....Sell or hold

Post by livesoft »

I understand that you LOVE Vanguard GNMA as shown by your previous threads:
http://www.bogleheads.org/forum/viewtop ... 0&t=123815
http://www.bogleheads.org/forum/viewtop ... 0&t=117948

GNMA has done BETTER than any other intermediate bond fund in that time frame, right? And that includes Total Bond. Aren't you happy that you used GNMA instead of Total Bond?

OK, sell your GNMA and buy a short-term corporate bond fund such as VSCSX.

PS: I look forward to your next GNMA thread in June 2014. :)
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hoops777
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Re: GNMA....Sell or hold

Post by hoops777 »

Livesoft if this was so easy there would not be so many conflicting ideas posted by many of the the most esteemed bogleheads.You are right that I like GNMA and how well it has done over many years,but this is Jan 2014 and I have not seen anyone saying buy VFIIX and quite a lot of the opposite.The last time I posted there was the topic of negative convexity or whatever it was called that applied only to GNMA's.Even the great Bob Brinker :D who championed them for many years has abandoned them.Between my wife and I they probably total 25% of our total investments....thus my concern.
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Re: GNMA....Sell or hold

Post by livesoft »

You do realize I hope that you will be concerned for the rest of your life. If you get out of GNMA, you will simply be concerned about what you replace it with.

Perhaps the road to investing nirvana is to let go and not be concerned about any of your investments.
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Re: GNMA....Sell or hold

Post by Valuethinker »

hoops777 wrote:.The last time I posted there was the topic of negative convexity or whatever it was called that applied only to GNMA's..
No, all Mortgage Backed Securities have negative convexity: Freddie and Fannie paper too. FNMA and FMAC used to have greater credit risk than GNMA but they don't know because the US government owns 100% of them.

If you have 25% of your wealth in GNMA fund, I'd diversify into Total Bond Fund, in your shoes.
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Re: GNMA....Sell or hold

Post by hoops777 »

You are of course correct.Just trying to figure out which One I would worry about less :D Thank you Livesoft.I know that my posts annoy you greatly with good reason :D
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Re: GNMA....Sell or hold

Post by hoops777 »

Thanks Valuethinker.
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Re: GNMA....Sell or hold

Post by nisiprius »

This is sort of interesting... Because Total Bond only goes back to 1987 I've had a tendency to compare GNMA to Total Bond over that time period. GNMA has tended to have a very slight edge. But in fact that seems to be because Total Bond has lagged its index from time to time. If you compare GNMA to the Barclay's index itself, one thing that leaps out is that from 1986 to present, there's amazingly little difference between the two:

Image

And from 8/1/1980 to 1985, there's amazingly little difference between the two--WARNING, I snipped off three months at the beginning in order to make the chart come out the way I wanted it to, the fund stumbled right at the beginning:

Image

Yet, overall, there's a distinct lag, a 6-7% drop, and it all seems to have happened in one very short period around 1985:

Image

Image

So, I would say maybe it would be a good idea to find out if something happened in March and April of 1986 that you need to know about. On the other hand, that data for the index looks a little funky--obviously it's only at 1 month intervals--but it's not the the fund had a drop down, it's that the index had a leap up that the fund didn't follow--so maybe it's some kind of Morningstar data glitch.
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Re: GNMA....Sell or hold

Post by hoops777 »

Thanks Nisprius.I am certain more than a few people here will be surprised by this.The main thing I take from your info is that since the returns have been almost identical it would make sense to switch it to the more diversified fund....I guess :happy
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Re: GNMA....Sell or hold

Post by nedsaid »

Boy, I don't know why so many people are spooked by Ginnie Mae's. I have owned a GNMA fund through my workplace savings plan and it has performed like a champ!! People are spooked by the "extension" and "refinance" risks in GNMA's which I think are way overblown.

Extension risk is that when interest rates rise that people will tend to hold on to their mortgages and of course the refinancing risk occurs when interest rates fall. The theory is that you get more downside than from normal bonds when rates go up and less upside when interest rates fall due to refinancing.

People forget that corporate bonds often have call dates on them, corporations can refinance just as homeowners can. People move around a lot so a 30 year mortgage is really only 7 or 8 years because of that. Also with each mortgage payment, one gets back both principal and interest so the average maturity on a 30 year mortgage is something like 12 years.

So GNMA's might have a tiny bit more risk that the Total Bond Market Index but it is so tiny as to be unnoticed by most investors. Plus GNMA's are US Government backed. So no default risk.

Why are people so spooked by these? I honestly am a bit mystified.
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Re: GNMA....Sell or hold

Post by Valuethinker »

nedsaid wrote:Boy, I don't know why so many people are spooked by Ginnie Mae's. I have owned a GNMA fund through my workplace savings plan and it has performed like a champ!! People are spooked by the "extension" and "refinance" risks in GNMA's which I think are way overblown.
"which I think are way overblown"

You are implying you have access to the sort of sophisticated models people who trade these bonds use. And perfect knowledge of future interest rates.

As a start, have you done the CFA? There was a whole unit on this, from memory (this was back in the early 1990s).
Extension risk is that when interest rates rise that people will tend to hold on to their mortgages and of course the refinancing risk occurs when interest rates fall. The theory is that you get more downside than from normal bonds when rates go up and less upside when interest rates fall due to refinancing.
Also called negative convexity. Not a theory btw, a reality-- a known characteristic of the bonds. There are structural issues too-- when it became possible to refinance your mortgage over the internet, there was a sharp increase in refi rates.
People forget that corporate bonds often have call dates on them, corporations can refinance just as homeowners can.
And so Vanguard TBM avoids such bonds, to a great extent.
People move around a lot so a 30 year mortgage is really only 7 or 8 years because of that. Also with each mortgage payment, one gets back both principal and interest so the average maturity on a 30 year mortgage is something like 12 years.
At very low interest rates for a 30 year mortgage that is less true-- duration stretches. On the first point, there was a CFA presentation I saw that showed the average life of a GNMA pool was 8 years- a number which seemed to me to be shockingly low (given these are 30 year mortgages). The implication of course is that extension risk is high.
So GNMA's might have a tiny bit more risk that the Total Bond Market Index but it is so tiny as to be unnoticed by most investors. Plus GNMA's are US Government backed. So no default risk.

Why are people so spooked by these? I honestly am a bit mystified.
Because we've all read Liar's Poker, read Richard Bookstaber's 'A Demon of our Own Design' (in the footnotes, the author, a former head of risk at Morgan Stanley, makes a specific reference to Mortgage Backed Securities and their risks), done the CFA. Read Fabozzi.

Or you could just read Larry Swedroe's chapter on them in his bond book, which in layman's language takes you through the issue. An easy way to put it is 'No Such Thing as a Free Lunch' (TANSTAAFL) in financial markets.

What's striking about GNMAs is that you have *not* been compensated for that extra risk over time. I would have thought you should make c. 100 basis points higher annual returns given the characteristics of the bonds. But, in fact, you have not, returns have pretty much tracked other US government guaranteed bonds.

GNMA risks would show up if there are large movements in interest rates. Like for example if a large holder of Mortgage Backed Securities announced they were stopping buying, or even beginning to 'taper' down their holdings.... oh wait....

25% of your assets in a GNMA fund is too much. The risks of a serious underperformance are probably low, but it's a lot of money to bet on the risk never showing up.
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Re: GNMA....Sell or hold

Post by Levett »

"What's striking about GNMAs is that you have *not* been compensated for that extra risk over time."

And that is a salient point.

Lev
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Re: GNMA....Sell or hold

Post by Valuethinker »

Levett wrote:"What's striking about GNMAs is that you have *not* been compensated for that extra risk over time."

And that is a salient point.

Lev
The counterargument is the risks are not what we thought.

What I *think* is going on is that the forces which caused a secular EDIT: bull market for bonds in the last 30 years (falling interest rates) affected Treasuries and GNMAs similarly, and since GNMAs had higher coupons to start with (or so I presume), they should have shown higher returns-- so refinancing hit investors. And at the end, credit quality became of great concern, and US Treasuries (and GNMAs) had no credit risk so they moved similarly. Then QE kicked in, with the Fed becoming a huge buyer of MBS and Treasury bonds.

Whilst bonds can have a bear market (see 1994) generally we haven't seen the sort of abrupt moves (up) in interest rates where extension risk might come and really bite us.

It is worth observing Nisi's point, that it's probably a 10% underperformance risk (my quantification), not a 20%.

There is nothing though in option theory, nor in efficient market theory, that says the risk premium can't increase as well as decrease (which would imply lower bond prices).

Which leads to 2 caveats:

- just because something hasn't happened, does not mean that it will never happen- -given we know the design of the security allows it to happen. In effect the mortgage holder has a right to 'put' his mortgage back onto the bondholder and that option will not always be in the money

- if you have 25% of your wealth in GNMA fund, then you have to worry about this more than if you have 25% in TBM (about 30% in MBS, and the manager is cognizant of the risk, and adjusts the portfolio accordingly)
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Re: GNMA....Sell or hold

Post by nedsaid »

Valuethinker, I have OWNED this fund since 1999 and have watched how it has actually performed. It has performed in a very similar manner to the Total Bond Market. Am I not supposed to believe what my eyes have been telling me? I just have not seen all this extra risk that folks have worried about.

I would rate these as riskier than Treasuries in terms of volatility but both GNMA's and Treasuries have US Government backing. But I just have not seen all this volatility that folks have worried about.

If we see abrupt rises in interest rates, I can see some extra risks in GNMA's. But this affects ALL bonds. GNMA's would be affected a bit more. My Gosh, GNMA's showed a lot less volatility in 2013 than TIPS. TIPS were down 9%!! And at times during 2013, GNMA's were down a bit less than the Total Bond Market Index.

So yes there is extension risk when rates go up and the refinancing when rates go down. But still these have performed pretty much in line with the total market.

I own a pretty diversified fixed income portfolio. I own Total Bond Market, TIPS, GNMA's, Savings Bonds, and good old fashioned money in the bank. I don't have anywhere near 25% of my portfolio in GNMA's.

I also want to point out that at the darkest point of the financial crisis, that General Electric could not roll over its commercial paper. The US Government had to step in and guarantee money market funds. The "safe" money market funds were not so safe after all. Demand for anything but Treasuries just dried up. The GNMA fund that I owned just sailed right through all of this.
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Re: GNMA....Sell or hold

Post by Levett »

Hi VT,

I assume when you wrote the following--"the forces which caused a secular bear market for bonds in the last 30 years (falling interest rates)"--you meant to say "bull market."

Lev
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Re: GNMA....Sell or hold

Post by YDNAL »

hoops777 wrote:I bought a large amount of VFIIX about 15 months ago.
What changed in 15 months? Are you investing trading in 1.25-year intervals?
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Re: GNMA....Sell or hold

Post by Valuethinker »

Levett wrote:Hi VT,

I assume when you wrote the following--"the forces which caused a secular bear market for bonds in the last 30 years (falling interest rates)"--you meant to say "bull market."

Lev
Agreed. Thanks.
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Re: GNMA....Sell or hold

Post by hoops777 »

The first guy I ever listened to regarding investing was Bob Brinker on the radio.He was always talking about how great GNMA were and it has found a place deep inside my brain.I believe I will be switching them to the total bond.
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Re: GNMA....Sell or hold

Post by livesoft »

hoops777 wrote:The first guy I ever listened to regarding investing was Bob Brinker on the radio.He was always talking about how great GNMA were and it has found a place deep inside my brain.I believe I will be switching them to the total bond.
But isn't that what you wrote last year? :) And aren't you glad you didn't since you made more money in GNMA than you would have if you had switched?
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Re: GNMA....Sell or hold

Post by hoops777 »

Livesoft....I know you believe this is trivial,but the first time in my life I ever had any money and started to invest was in the mid to late 90's in the middle of the dot com craziness.The only people I knew who were investing were guys into day trading.The only reasonable voice I heard was Brinker.I started subscribing to all kinds of newsletters and watched CNBC.I am the poster boy for what not to do.I probably have the worse background of anyone on this entire boglehead site.If you had a boglehead Special forces unit I would be under lock and key.Anyway,I know what to do and I appreciate all of the feedback and I promise on 1/31/2014 that I will never post about GNMA again.My value to this site is that you need to have some annoying or clueless posters to make you guys look good :D
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Re: GNMA....Sell or hold

Post by livesoft »

Excellent! :sharebeer
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Re: GNMA....Sell or hold

Post by nedsaid »

Whew!! I am glad GNMA's aren't such a bad investment after all.

We had the Great Boglehead Bond Panic of 2013. Now the Stock Panic of 2014, and now GNMAs seemed to be so dangerous that folks were running for the hills!!!

I think a good GNMA fund is an excellent investment. One would expect that it would do best during times of stable interest rates. But during 2013, they were pretty well behaved. I was pretty impressed at how well these funds weathered the 2008-2009 financial crisis and the 2013 downturn in bonds. I suppose someday GNMAs will show the unique risks that Valuethinker talked about but I have a very diversified fixed income portfolio and this should be no big deal. Just as TIPS had a really bad 2013 but didn't crash my portfolio, I would expect to ride out any problems with GNMA's. And I would expect that GNMA's would rebound from a bad year.

And I am another of the Bob Brinker listeners. I learned about GNMAs from him. He taught me an awful lot about investments and the markets. He also introduced me to index funds.

So regardless of what other folks have said, investing in GNMA's is not the equivalent of playing with dynamite. These have their risks, but what asset class doesn't?
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Re: GNMA....Sell or hold

Post by dm200 »

Whatever the actual risks are (or might be) in holding the Vanguard GNMA fund, in an impartial and objective sense, it seems to me that if holding the fund causes you to worry, second guess your decisions on having bought the fund, and so on - then I suggest divesting yourself of the fund completely and find somewhere that will not cause any such anxiety.
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Re: GNMA....Sell or hold

Post by livesoft »

Vanguard GNMA up 2% YTD. Total US Bond up a mere 1.5%. I suppose one can argue with success, but why would you want to?

But rebalancing out of GNMA into Total US Bond now would "lock in" that 0.5% advantage for the rest of the year.
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Re: GNMA....Sell or hold

Post by z3r0c00l »

Do whatever it takes to stop changing your strategy every 15 months.
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Re: GNMA....Sell or hold

Post by dm200 »

z3r0c00l wrote:Do whatever it takes to stop changing your strategy every 15 months.
Absolutely - such changing strategy so often, and the "stress" involved in doing/deciding what to do or not do, (in my opinion) should be avoided.
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Re: GNMA....Sell or hold

Post by Valuethinker »

nedsaid wrote:I also want to point out that at the darkest point of the financial crisis, that General Electric could not roll over its commercial paper. The US Government had to step in and guarantee money market funds. The "safe" money market funds were not so safe after all. Demand for anything but Treasuries just dried up. The GNMA fund that I owned just sailed right through all of this.
As long as you understand that you are not comparing like for like, and therefore it's not relevant.

GNMA bonds are bonds (long term securities). MMFs are securities up to 1 year. The shadow banking crisis was about liquidity drying up ie in money markets.

The relevant comparison is between US T Bills and GE paper *not* GNMA bonds. *All* US Treasury backed securities remained liquid during the crisis. (correction: TIPS did not, an important reason for their underperformance).
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Re: GNMA....Sell or hold

Post by Valuethinker »

hoops777 wrote:The first guy I ever listened to regarding investing was Bob Brinker on the radio.He was always talking about how great GNMA were and it has found a place deep inside my brain.I believe I will be switching them to the total bond.
Or split the difference. It's not that GNMA fund is bad, it's that it has buried in it an option by the borrower to repay the lender early.

The option premium varies over time. It means in effect that GNMA bonds have increased interest rate risk compared to conventional US Treasury Bonds. Whether the additional yield compensates the investor for that is a matter open to debate. But the first 2 statements in this sentence are unambiguously as true as anything in finance can be said to be true.

How large is the difference in performance likely to be between a GNMA fund and a US Treasury Bond fund? At a guess (and only that) not more than -10% underperformance in a given year. And usually much less than that.
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Re: GNMA....Sell or hold

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Valuethinker, you missed my point entirely. Yes, GNMAs are not like commercial paper. GNMAs are mortgages and commercial paper is short term. I understand that.

What I was talking about was that all asset classes have their unique risks. I would agree that GNMAs are riskier than lets say short term treasuries. Both have a government guarantee, one is longer term and the other is shorter term.

My point was that even "safe" investments like the short term money market funds which have things in them like commercial paper suffered a rare crisis in which some pretty big risks showed up. In normal times, AAA rated GE Commercial Paper is as safe as you get without a Government guarantee. But the credit market dried up and there were
no buyers for this paper.

"Dangerous" GNMAs do have Uncle Sam's guarantee behind them, you have that principal and interest guarantee. The government had to guarantee the "safe" money market funds to stop the run. The "Dangerous" GNMAs actually fared pretty well through a big credit crisis.

I agree that there are unique credit market conditions that could affect GNMAs more than other classes of bonds. Like for instance a sudden jump in interest rates. This would affect GNMAs a bit more than other bonds because of the extension risk we talked about earlier. But this would be a temporary effect.

I would argue that all asset classes have hidden risks in them that show up when unexpected conditions show up in the markets. GNMAs have their unique risks. We have seen the unique risks of TIPS in the financial crisis and again in 2013. Even money market funds show unique risks. I have read articles that Treasuries might have a lot of risk in them because of being overvalued. I don't think GNMA's are as scary as many posters have opined. In fact, they have been pretty well behaved in recent years.

My TIPS funds were down 9% in 2013. I didn't sell and in fact have bought more. I realized those darned things are volatile but I want them in there for inflation protection. I don't have a large allocation to them. If anything, this thread ought to be about TIPS and not GNMAs.
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Re: GNMA....Sell or hold

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[Edited]
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Re: GNMA....Sell or hold

Post by nedsaid »

Another point is that markets have a way of doing the very thing you never expected or never thought of. Since I believe that all asset classes and subclasses have their own unique risks, this is why an investor should widely diversify. Asset classes have a way of confounding investor expectations, particularly in a really bad market or during a crisis.

GNMAs have performed pretty well and have been well-behaved in recent history. But who knows, a rare event could come up that causes these to vastly underperform the broad bond market for a time. So as much as I like these, one should diversify their bonds just like we diversify our stocks. I would not replace Total Bond Market with GNMAs. I just think of them as another tool for the toolkit.
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Re: GNMA....Sell or hold

Post by grabiner »

Valuethinker wrote:
hoops777 wrote:.The last time I posted there was the topic of negative convexity or whatever it was called that applied only to GNMA's..
No, all Mortgage Backed Securities have negative convexity: Freddie and Fannie paper too. FNMA and FMAC used to have greater credit risk than GNMA but they don't know because the US government owns 100% of them.
Callable bonds also have negative convexity. If interest rates fall, a callable bond will be called, reducing its duration; if rates rise, it won't be called, and will have the same duration as a non-callable bond.

(In fact, this is the same effect which affects mortgage-backed securities. If interest rates fall, mortgage-holders will pay off their mortgages by refinancing at lower rates, reducing the duration of these bonds.)
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Re: GNMA....Sell or hold

Post by mhalley »

For the poster that mentioned Bob Brinker, he has sold his gnma funds in his market timer portoflios.
I heard him mention this on Money talk the other day. Since I don't subscribe, I don't know when he made the call to sell them.
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Re: GNMA....Sell or hold

Post by Valuethinker »

mhalley wrote:For the poster that mentioned Bob Brinker, he has sold his gnma funds in his market timer portoflios.
I heard him mention this on Money talk the other day. Since I don't subscribe, I don't know when he made the call to sell them.
Mike
Nice to know Bob Brinker thinks it is time to get out. Ranks up there with William Bernstein, Larry Swedroe, and of course Larry Fink, a man who has made literally billions out of the Mortgage Backed Securities market ;-) ?

I have reached that stage where I should realize that just because something is standard in the CFA syllabus, and something that Larry Swedroe deconstructs in layman's language rather well in his bond book, doesn't mean that you can make someone understand.

This notion of a risk which is quite unpredictable and whose magnitude shifts over time, and shifts against the investor.

All they can see is historic performance. And that was fine, and therefore it will be in the future. Because a risk hasn't shown up (or was overpowered by other factors) means it will never show up.

I have deleted my further thoughts, because there is no point stating them.

For the original poster, with 25% in GNMA fund, this could have a significant impact on final wealth. Hopefully not too significant, but it's hard in advance of the fact to know how one will feel when one's 'safe' bond fund underperforms by say 10% (I don't view it as a high probability that it would do worse than that, but, in truth, who knows? The Federal Reserve QE programme owns an awful lot of these things).
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Re: GNMA....Sell or hold

Post by Valuethinker »

grabiner wrote:
Valuethinker wrote:
hoops777 wrote:.The last time I posted there was the topic of negative convexity or whatever it was called that applied only to GNMA's..
No, all Mortgage Backed Securities have negative convexity: Freddie and Fannie paper too. FNMA and FMAC used to have greater credit risk than GNMA but they don't know because the US government owns 100% of them.
Callable bonds also have negative convexity. If interest rates fall, a callable bond will be called, reducing its duration; if rates rise, it won't be called, and will have the same duration as a non-callable bond.

(In fact, this is the same effect which affects mortgage-backed securities. If interest rates fall, mortgage-holders will pay off their mortgages by refinancing at lower rates, reducing the duration of these bonds.)

As I understand it, the Vanguard Corporate Bond fund therefore avoids most callable issues (being actively managed, it can). Similarly the GNMA fund uses relatively short maturity securities (the underlying mortgage pool is well aged) when the managers believe there is a risk of an upward tick in interest rates (as I understand it).
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Re: GNMA....Sell or hold

Post by grabiner »

Valuethinker wrote:As I understand it, the Vanguard Corporate Bond fund therefore avoids most callable issues (being actively managed, it can). Similarly the GNMA fund uses relatively short maturity securities (the underlying mortgage pool is well aged) when the managers believe there is a risk of an upward tick in interest rates (as I understand it).
I don't think the GNMA fund tries to time the market in this way; GNMAs with relatively new mortgages may be good deals because everyone recognizes the risk of prepayment and demands a higher yield in return for the risk premium. It makes more sense to hold a GNMA portfolio which is diversified across underlying mortgage rates and origin dates, as this moderates the risk.
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Re: GNMA....Sell or hold

Post by Valuethinker »

grabiner wrote:
Valuethinker wrote:As I understand it, the Vanguard Corporate Bond fund therefore avoids most callable issues (being actively managed, it can). Similarly the GNMA fund uses relatively short maturity securities (the underlying mortgage pool is well aged) when the managers believe there is a risk of an upward tick in interest rates (as I understand it).
I don't think the GNMA fund tries to time the market in this way; GNMAs with relatively new mortgages may be good deals because everyone recognizes the risk of prepayment and demands a higher yield in return for the risk premium. It makes more sense to hold a GNMA portfolio which is diversified across underlying mortgage rates and origin dates, as this moderates the risk.
If you think interest rates are a 1 way bet though (ie up from here, not down) then you want securities which are less vulnerable to extension risk. I believe someone showed me a piece by the fund manager of GNMA fund where he said that was what they were doing.

There are probably some quite clever ways of estimating who is going to extend (or prepay) in a pool of mortgages.

One thing I do remember reading is that prepayment increased significantly when it became easy to do the application over the internet. There are structural changes in the mortgage market which are not to do with interest rates.

I also believe that with fallen housing prices, it has been more difficult to refinance, thus prepayment risk has been lower than might otherwise have been expected given the falls in interest rates in the last few years.
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Re: GNMA....Sell or hold

Post by SpringMan »

Valuethinker wrote: As I understand it, the Vanguard Corporate Bond fund therefore avoids most callable issues (being actively managed, it can). Similarly the GNMA fund uses relatively short maturity securities (the underlying mortgage pool is well aged) when the managers believe there is a risk of an upward tick in interest rates (as I understand it).
Aren't the Vanguard Corporate Bond funds index funds? VSCSX is Vanguard Short Term Corporate Index fund and VICSX is the Intermediate Term Corporate Index fund. The investment grade funds, VFSUX and VFIDX are not pure corporate, they also have some treasuries. The question would be do the index funds avoid callable bonds?
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Re: GNMA....Sell or hold

Post by Valuethinker »

SpringMan wrote:
Valuethinker wrote: As I understand it, the Vanguard Corporate Bond fund therefore avoids most callable issues (being actively managed, it can). Similarly the GNMA fund uses relatively short maturity securities (the underlying mortgage pool is well aged) when the managers believe there is a risk of an upward tick in interest rates (as I understand it).
Aren't the Vanguard Corporate Bond funds index funds? VSCSX is Vanguard Short Term Corporate Index fund and VICSX is the Intermediate Term Corporate Index fund. The investment grade funds, VFSUX and VFIDX are not pure corporate, they also have some treasuries. The question would be do the index funds avoid callable bonds?
This is a 1 year old thread that has been revived.

I don't know the answers to your questions but perhaps surfing the website might give you some info.

I would expect an index fund to hold callable bonds, if they are in the underlying index.
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Re: GNMA....Sell or hold

Post by Dandy »

I used to own a small allocation to VG GNMA. I sold it to simplify my fixed income portfolio a bit. People raise the important issue of convexity but no matter what seems to happen VG GNMA keeps chugging along. I would not put the bulk of your fixed income in it but it isn't a bad choice for some of your fixed income.
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Re: GNMA....Sell or hold

Post by garlandwhizzer »

Like nedsaid, I get a little tired of people beating up on GNMAs. The bond market is in my opinion generally a very efficient pricing mechanism between risk and yield. GNMAs are on the efficient frontier of that spectrum, a bit riskier than Treasuries but with higher yields. They fit in between investment grade corporates and Treasuries on that risk/reward spectrum. They do not have default risk but they do have problems when mortgage rates are unstable, either rising or falling rapidly. They tend to perform well, often better than Treasuries, when mortgage rates are relatively stable. You are reimbursed for negative convexity. I don't always use them but sometimes I do and I have been happy with the results. Like nedsaid, Bob Brinker was the one who introduced them to me many years ago.

Everyone seems to be in love with Treasuries and this is easy to understand. But I am a conscientious objector to any 10 year bond instrument that yields 1.75% nominal, no matter how much the crowd loves it. Groupthink is not always right. Treasuries at current yields are very much subject interest rate risk if and when inflation takes off. At that point the communal love affair with Treasuries might turn a little sour.

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Re: GNMA....Sell or hold

Post by nisiprius »

garlandwhizzer wrote:...Treasuries at current yields are very much subject interest rate risk if and when inflation takes off. At that point the communal love affair with Treasuries might turn a little sour...
Why would GNMA's be any different?
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Re: GNMA....Sell or hold

Post by garlandwhizzer »

In response to my post,
garlandwhizzer wrote:
...Treasuries at current yields are very much subject interest rate risk if and when inflation takes off. At that point the communal love affair with Treasuries might turn a little sour...

Nisi asked, Why would GNMA's be any different?
Good question. GNMAs would also suffer some principal losses as well. How much principal loss depends on how quickly the effective duration changes. Although GNMAs have a shorter duration at present than say the intermediate term Treasury fund, we would expect that GNMA's duration would increase in that environment. How much a factor that is very hard to predict. People don't stop buying houses in an inflationary environment so new GNMA bonds keep being issued. Offsetting that increasing duration is the yield difference. Since GNMAs yield more, reinvesting dividends buys more GNMAs monthly than Treasuries yielding less. Increasing yields therefore increase portfolio turnover which buys more GNMAs at higher interest rates. So negative convexity lines up against increased yield in an inflationary environment. Exactly which--Treasuries or GNMAs--will outperform under these circumstances in not clear to me at least.

Currently the Intermediate Term Treasury fund has an SEC yield of 1.19% with a duration of 5.2 years. Currently GNMA has a SEC yield of 2.29%, almost 100% higher and a shorter duration at 4.6 years. That higher yield turns over the portfolio into higher bonds in a rising rate environment when you reinvest dividends. Also unless home buying stops completely (which has never happened) newly issued GNMAs with higher rates are constantly being added to the bond portfolio during an inflationary cycle.

Personally I believe the negative convexity risk of GNMAs is overblown. I also believe the default risk of short and intermediate term investment grade corporate bonds is currently overblown. I am in the minority on these views but my investing experience tells me that when anything that is as popular and universally loved as Treasuries are at present, that may be the time to become a bit cautious on their future return prospects.

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Re: GNMA....Sell or hold

Post by nedsaid »

It is interesting that this thread got revived after a year. I guess the dead horse was in rigor mortis and started twitching and it was decided to beat it again.

I want to retract all my comments about the supposed dangers of GNMA's, I have seen the error of my ways and am making my way to the mourner's bench to repent of my evil ways.

I bought my GNMA fund at my workplace savings plan in 1999 when I was 40 years old and added to it for about nine years. I still own shares in that fund through my workplace savings plan and also own another GNMA fund in a mutual fund IRA. I am now 55 and I have reaped the harvest of my evil ways having experienced hair falling out, sagging skin, receding gum lines, yellowing teeth, and a bit of weight gain. I noticed that this seem to happen faster after buying GNMA's for the first time in 1999. And can I add to that slightly graying hair, that is whatever is still left.

So I am putting the warning out for all Bogleheads out there to not follow my bad example and dangerous investing ways. Otherwise, you might end up just like me having justly reaped the bitter harvest of my prodigal ways. So be warned!!
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Re: GNMA....Sell or hold

Post by hoops777 »

Thanks Nedsaid...I actually started all this a year ago and I ended up keeping half my GNMA.I used all the GMNA I sold and some other money to buy a good amount of 10 year brokered CD's yielding 3.4 last March.I never did buy the total bond. :D Happy with that decision.
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Re: GNMA....Sell or hold

Post by Valuethinker »

nisiprius wrote:
garlandwhizzer wrote:...Treasuries at current yields are very much subject interest rate risk if and when inflation takes off. At that point the communal love affair with Treasuries might turn a little sour...
Why would GNMA's be any different?
As per garland whizzer:

- extension risk - Mortgage Backed Securities in their US form have the property that if interest rates rise, mortgagees don't repay as expected

Thus the duration of the bond moves out when there are interest rate rises 'negative convexity'.

That's different from US Treasuries. I believe the VG fund manager considers this risk when it chooses which GNMA bonds to buy, and buys ones where the pool of mortgages is less likely to sustain extension risk -- I vaguely remember reading an interviewer to this effect.
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Re: GNMA....Sell or hold

Post by Northern Flicker »

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Re: GNMA....Sell or hold

Post by nedsaid »

It is interesting that this thread got revived AGAIN. I still own my GNMA funds but I have not added to them. I googled and found a Larry Swedroe article about GNMA's and why he does not like them. Oddly enough, he doesn't like Vanguard Total Bond Market Index either because of its 30% holding in mortgage backed securities.

So I suppose those of us who own Vanguard Total Bond Market need to look for alternatives as apparently this is not a good enough investment!

I for one am not selling my GNMA funds but then again are only a part of my bond investments. I am not selling my Vanguard Total Bond Market Index either, which I now own in both fund and ETF form. Another big holding is a diversified bond fund which also has Mortgage Backed Securities in it. There doesn't seem to be any way to escape other than pure Treasury funds.

So like anything else, it is a good idea to not be overloaded on anything. Be widely diversified.
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Re: GNMA....Sell or hold

Post by Northern Flicker »

I think the market is likely to set a fair market value for GNMA's so that the yield above similar duration treasuries should be fair compensation for the dampened upside with falling rates.

The convexity issue with rising rates is a bit of a red herring. Because there is less upside than with treasuries when rates fall, the yield doesn't fall as far, so, the telescoping duration during rising rates will also generally apply to a smaller rise in yield than would be experienced by a treasury. As a result, I think GNMA's usually have less volatility than treasuries.

Socially responsible-identified investors may also prefer GNMAs (FHA and VA mortgages) to the corporate bonds in TBM.
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