Hot, New Item Offers Stability, Good Returns
Mutual fund companies are always trying to build a better mouse trap, and the Franklin group of San Mateo, Calif., seems to have constructed a winner with its Adjustable U.S. Government Securities Fund.
To lure investors, the fund offers greater stability than bond portfolios and higher returns than money market funds. Recently, that has proved to be an irresistible combination. “A few years ago, people finally got used to single-digit money fund yields, but now yields in the 6% range are scaring them,” says Jack Heilbron of Centurion Counsel, a San Diego investment management company that specializes in mutual funds.
Short-term interest rates have been falling since last summer, which helps explain why Franklin’s fund has been snaring $120 million to $150 million a month in new money since then, reports David Yuen, the portfolio’s co-manager. A new name also helped. The portfolio had been called the Franklin Adjustable-Rate Mortgage Fund, but that nomenclature apparently confused people. “The name change explains a large part of the sales increase,” says Yuen.
At any rate, the 42-month-old fund currently weighs in with $1.67 billion in assets, up from a mere $67 million at the start of 1990. This rapid growth has attracted the attention of other fund companies, a few of which have come out with competing products within the past two months.
The Franklin fund invests in bond-like securities that are backed by pools of home mortgages. There’s nothing revolutionary about this. Anyone can buy a mortgage-backed certificate issued and guaranteed by such agencies as the Federal Home Loan Mortgage Corp. (Freddie Mac), the Federal National Mortgage Assn. (Fannie Mae) and the Government National Mortgage Assn. (Ginnie Mae). Washington guarantees the timely payment of principal and interest on these securities, either overtly or implicitly.
In fact, mutual funds that hold these assets have been popular since the early 1980s, in part because they offer somewhat higher yields than Treasury securities, to which they’re often compared.
However, Franklin’s portfolio parts company in that it invests only in poolings of adjustable-rate mortgages. “The rates on the loans readjust every 3.5 months on average,” says Yuen. Because the yields (and thus the fund’s monthly dividends) vary, the prices of the securities remain fairly stable. Franklin’s fund debuted at $10 a share in late October, 1987, and has stayed between $9.93 and $10.33 since.
But while it’s hardly risky, the Franklin portfolio doesn’t offer the stability of money market funds, which maintain a constant price.
As another distinction, money funds don’t carry up-front sales charges or loads. Franklin Adjustable U.S. Government Securities imposes a 4% fee--a hurdle that makes the fund worthwhile only for people willing to park their cash for at least a couple of years. While Franklin’s portfolio outperformed the average government money market fund from 1988 through ’90 (29.1% to 24.8%), that advantage evaporates when you factor in the 4% charge.
Heilbron predicts that the eventual emergence of no-load competitors in the adjustable-rate arena will force companies such as Franklin to shave their sales fees. “I see a parallel with some of the early money market funds, some of which paid a load,” he says.
Besides Franklin (800-342-5236), the other leading companies with adjustable-rate mortgage funds include Keystone America (3.5% load; 800-343-2898) and Pilgrim (4% maximum back-end load; 800-334-3444).
Certainly, the Franklin Adjustable U.S. Government Securities Fund delivers competitive yields with a minimum of price fluctuations. However, it doesn’t offer much capital gains potential should interest rates decline. If you can stomach a bit more volatility in return for greater long-term potential, you might fare better with other categories of bond funds. The average mortgage-securities fund tracked by Morningstar Inc. returned 31.9% from 1988 through ‘90, compared to 29.1% for Franklin’s portfolio.
The choices also include other types of short-term portfolios, including those that purchase corporate, government or municipal securities coming due within two or three years.
In general, the sooner a bond matures, the less its price will be affected by interest rate swings. Any of these short-term vehicles would hold up reasonably well assuming rates spiked higher, although a straight money fund would offer greater protection.
A particularly hot-selling product of late has been the short-term global funds, which seek to capture the higher yields available in certain foreign markets.
Several of these portfolios make use of hedging strategies to reduce the considerable currency risk, and so far this approach seems to be working. For example, the New York-based Alliance Short-Term Multi-Market Trust, the oldest fund of this kind, has returned 26% since its inception in May, 1989.
And even on many other types of fixed-income funds, including those that take longer-term positions, the price volatility usually isn’t that great. Bond funds are, after all, bond funds. Most won’t cost you much sleep at night.
