Mortgage-backed securities (MBS) recorded positive returns during the first quarter but underperformed the broader U.S. investment-grade bond market. While demand was solid, an increase in new MBS supply; elevated volatility; and declining Treasury yields, which finished at their lowest quarter-end levels in four years, weighed on the asset class. Lower yields can trigger increased levels of prepayments on the mortgages backing MBS, hurting their values. The early-year volatility in global financial markets seemed to convince the Federal Reserve to delay interest rate hikes despite signs of increasing health in the U.S. economy, including a strong labor market. In the statement following its March monetary policy meeting, the Fed reiterated its plan to continue to reinvest principal payments from its holdings of MBS until interest rate normalization "is well under way."
The GNMA Fund returned 1.43% in the quarter compared with 1.75% for the Barclays U.S. GNMA Index and 1.33% for the Lipper GNMA Funds Average. For the 12 months ended March 31, 2016, the fund returned 1.57% versus 2.40% for the Barclays U.S. GNMA Index and 1.16% for the Lipper GNMA Funds Average. The fund's average annual total returns were 1.57%, 2.80%, and 4.33% for the 1-, 5-, and 10-year periods, respectively, as of March 31, 2016. The fund's expense ratio was 0.59% as of its fiscal year ended May 31, 2015.
For up-to-date standardized total returns, including the most recent month-end performance, please click on the Performance tab, above.
Current performance may be lower or higher than the quoted past performance, which cannot guarantee future results.
Share price, principal value, and return will vary and you may have a gain or loss when you sell your shares.
We took advantage of relative valuations to increase our position in longer-maturity MBS while trimming our holdings of commercial mortgage-backed securities. We structure the portfolio to provide shareholders with the most attractive risk-appropriate opportunities in the market, and balancing the cost of liquidity against risk level is an integral part of our investment and risk-monitoring process. The management team also uses internally and externally developed quantitative tools to track and manage the risk profile of the portfolio as market conditions change.
MBS appear to be closer to fair value in the context of lower Treasury rates, a continued divergence between market and Fed expectations for the pace of rate increases, and a seasonal pickup in supply on the back of continued strength in housing. We believe that the fundamentals of the market are positive, though a continued decline in the 10-year Treasury yield may bring prepayment concerns back into focus. The biggest risk to the sector would be a change in monetary policy that would lead the Fed to start reducing its reinvestments of principal payments on its MBS holdings sooner than is currently expected. However, after the central bank's dovish statement following its March meeting, this seems unlikely before 2017.