Faced with lowly 3.5 percent yields on certificates of deposit and money-market funds, investors are flocking to mutual funds that promise to pay as much as 8 percent, according to data gathered for Money magazine's Small Investor Index.
These funds invest in huge pools of mortgages backed by government-chartered agencies such as the Government National Mortgage Association (Ginnie Mae).At several mutual fund companies, these funds are now the hottest-selling income investments. For example, the Putnam U.S. Government Income Trust, with assets of $4.1 billion and an 8.1 percent yield, has attracted an astounding $1 billion of fresh cash so far this year. Similarly, the $395 million Scudder GNMA Fund, which pays 8 percent, had net sales of $18 million in May, compared with $6 million in January.
Although the government backing protects investors against losses resulting from defaults on the mortgages, Ginnie Mae funds' share prices can suffer if homeowners pay off large numbers of the mortgages. And with mortgage rates now at their lowest levels in 15 years, the number of re-fi-nanc-ings has quadrupled in the past year.
As a result, analysts warn that the funds' payouts may not be as generous as they look. Once the possible effect of mortgage refinancing is taken into account, "Some 8 percent Ginnie Mae funds are actually paying effective yields as low as 5.5 percent," said Robert Hennes, manager of the Investors Preference Fund for Income in Albany, N.Y.
To get an idea of a fund's real return, he advises potential investors to ask for its so-called 30-day SEC yield.
Last week, the Small Investor Index, which tracks the average individual's holdings, fell $210 to $45,929. Stocks lost $256, while bonds added $32. CDs and money funds contributed $14.