From the October 2006 issue of Investment Advisor • Subscribe!

Remember To Pay The Mortgage

Mortgage-backed securi-ties, a somewhat overlooked, though very large, section of the fixed-income universe, are becoming more attractive to investors in light of a softening housing market and slipping Treasury yields. Mortgage-backed securities, which represent an ownership in a group of mortgages and trade like bonds, provide higher yields relative to other fixed income vehicles. Moreover, with declines in construction spending and new housing sales, new mortgage applications and refinancings will likely decline--thereby, creating a tighter supply and increasing their value as investments.

Historically, mortgage-backed securities tended to outperform the broader fixed-income universe during periods of rising interest rates. Indeed, year-to-date through August 31, the Lehman Mortgage-Backed Securities Index gained 2.85%, versus a 2.16% rise for the Lehman Aggregate Index and a 1.72% return for the Lehman Government/ Credit Index.

One of the top fund performers in this sector, the $85-million Huntington Mortgage Securities Fund (HMTGX) can invest in mortgage-backed securities, as well as U.S. government bonds and real estate investment trusts (REITs).

As of June 30, portfolio managers William Doughty and Gustave Season-good had 55.0% of the fund's assets invested in mortgage-backed securities, 25.0% in Collateralized Mortgage Obligations, and 9.0% each in U.S. Agency Bonds and REITs. The bulk (56%) of the portfolio's assets carried a maturity of between 3-5 years.

Another consistent outperformer, the $520-million TCW Total Return Bond Fund (TGLMX) invests primarily in mortgage-backed securities. As of June 30, portfolio managers Jeffrey Gundlach and Phillip Barach had nearly half (48.6%) of the fund's assets invested in Agency Collateralized Mortgage Obligations, with 14.8% in Adjustable Rate Mortgages and 13.2% in Private Collateralized Mortgage Obligations.

The fund also carried an average yield to maturity of 5.82% and an average duration of 5.57 years.

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Mortgage-Backed Funds 3-Year Annualized Returns (through 8/31/06)

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