Prices of mortgage-backed securities (MBS) declined but held up better than similar-maturity Treasuries in the second quarter as light volumes of new mortgage origination and securitization provided support. The Federal Reserve did not raise interest rates at its June policy meeting, but generally strong U.S. economic data indicated that the central bank will begin to tighten monetary policy before the end of the year. Intermediate- and longer-term Treasury yields increased, which benefited MBS by making refinancing less attractive for homeowners. Refinancing causes prepayments of existing mortgages, which hurts the value of MBS backed by those mortgages. Housing market indicators pointed to continued strengthening, as data on May new and existing home sales were much better than expected.
The GNMA Fund returned −0.57% in the quarter compared with −0.62% for the Barclays U.S. GNMA Index and −0.42% for the Lipper GNMA Funds Average. For the 12 months ended June 30, 2015, the fund returned 1.59% versus 1.88% for the Barclays U.S. GNMA Index and 1.63% for the Lipper GNMA Funds Average. The fund's average annual total returns were 1.59%, 2.75%, and 4.20% for the 1-, 5-, and 10-year periods, respectively, as of June 30, 2015. The fund's expense ratio was 0.61% as of its fiscal year ended May 31, 2014.
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The liquidity and strong credit quality of agency MBS are key characteristics of the sector that continue to draw support from fixed income investors. We build the portfolio with the goal of providing shareholders with the most attractive risk-appropriate opportunities in the MBS market, focusing on securities that offer compelling relative value. The portfolio was underweight 15-year GNMAs in favor of 30-year securities. In order to reduce prepayment risk, the GNMA holdings were a combination of low-coupon MBS and seasoned higher-coupon bonds that have proven resistant to prepayment in past rate cycles. The portfolio also has allocations to MBS issued by Fannie Mae as well as to non-agency MBS.
Although the Fed is likely on track to raise rates later this year, we anticipate that the pace of rate hikes will be measured relative to historical cycles of monetary policy tightening. We expect an uptick in volatility in fixed income markets up to and around the time of the Fed's rate liftoff, but we don't anticipate a major liquidity crunch that would affect the MBS market. The relatively low levels of new MBS supply reaching the market should also provide ongoing technical support for the asset class. Security selection is still critical, however, and we will continue to rely heavily on our extensive team of analysts, who provide careful, fundamental research on individual bonds.