For the majority of the third quarter, the fixed income market featured rising yields and an aversion to securities with significant interest rate risk as investors widely anticipated that the Federal Reserve would begin to "taper" its asset purchases in September. However, on September 18, the Fed announced that it would maintain its current monthly pace of buying $45 billion in Treasuries and $40 billion in agency mortgage-backed securities (MBS). The delay in Fed tapering boosted fixed income market sentiment, benefiting GNMAs and other MBS in particular, as investors were relieved that the Fed would continue to provide a source of demand for the sector. Concerns over policy risk continue to weigh on higher-coupon MBS, however, as the President's nominee to head the Federal Housing Finance Agency appeared likely to push measures to further streamline existing refinance programs aimed at troubled homeowners, including new provisions for principal reductions. Higher-coupon MBS could see challenged performance as prepayments increase.
The GNMA Fund returned 0.68% in the quarter compared with 1.09% for the Barclays U.S. GNMA Index and 0.69% for the Lipper GNMA Funds Average. For the 12 months ended September 30, 2013, the fund returned −2.10% versus −1.90% for the Barclays U.S. GNMA Index and −2.60% for the Lipper GNMA Funds Average. The fund's average annual total returns were −2.10%, 4.64%, and 4.31% for the 1-, 5-, and 10-year periods, respectively, as of September 30, 2013. The fund's expense ratio was 0.59% as of its fiscal year ended May 31, 2013.
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Current performance may be lower or higher than the quoted past performance, which cannot guarantee future results.
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The portfolio maintains a modest allocation to non-agency MBS and collateralized mortgage obligations in an attempt to boost returns and provide diversification to the portfolio. These positions detracted a bit from relative results in the period, as they are generally somewhat more price sensitive to changes in interest rates. Our selection among GNMAs benefited performance, however, as we added to our holdings of lower-coupon GNMAs during the quarter, which outperformed after the Fed's decision in September.
With the strong performance in September, MBS valuations look much less appealing. The technical backdrop, however, remains very supportive. The supply of new issues has fallen this year due to higher mortgage rates, which has slowed housing and discouraged refinancing. On the demand side, while the Fed remains the marginal buyer, the central bank's purchases have been sufficient to not only absorb new supply but also to accommodate some profit taking on the part of private investors.