Mortgage-backed securities (MBS) finished the quarter down slightly but held up better than the broader U.S. investment-grade bond market. The Fed's statement following its December policy meeting, which announced the first increase in short-term rates in nine years, reassured MBS investors by saying that the central bank will continue to reinvest principal payments from its holdings of MBS until interest rate normalization "is well underway." Credit spreads on asset-backed securities remained near the widest points in recent years, attracting investors in search of yield. (Credit spreads measure the additional yield above that of a comparable-maturity Treasury security that investors demand for holding a bond with credit risk.)
The GNMA Fund returned −0.08% in the quarter compared with 0.16% for the Barclays U.S. GNMA Index and −0.14% for the Lipper GNMA Funds Average. For the 12 months ended December 31, 2015, the fund returned 0.88% versus 1.39% for the Barclays U.S. GNMA Index and 0.65% for the Lipper GNMA Funds Average. The fund's average annual total returns were 0.88%, 2.58%, and 4.16% for the 1-, 5-, and 10-year periods, respectively, as of December 31, 2015. The fund's expense ratio was 0.59% as of its fiscal year ended May 31, 2015.
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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 liquidity and strong credit quality of agency MBS are key characteristics of the sector that continues to draw support from fixed income investors. 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.
After outperforming in 2015, mortgage valuations look fair to modestly expensive in comparison with Treasuries and certain corporate debt sectors. Seasonal factors in the housing market will likely contribute to a beneficial environment for MBS for the next few months, however. The biggest risk to the sector would be a change in monetary policy that would lead the Fed to start reducing its reinvestments sooner than currently expected. The MBS market should continue to benefit from healthy demand for liquid bonds with high credit quality. Security selection is still critical, and we will continue to rely heavily on our extensive team of analysts, who provide careful, fundamental research on individual bonds.