A rising tide of criticism and concern about how Ginnie Mae funds are being sold is sweeping through the securities industry.
As the public's investment in Ginnie Mae funds approaches $20 billion, the Securities and Exchange Commission is cracking down on the free-wheeling ads that trumpet often illusory high yields to attract investors.
The SEC is demanding changes in Ginnie Mae fund sales literature to prevent investors from being misled about the yields and safety of what they are buying. The National Association of Securities Dealers and the Investment Company Institute -- the industry trade groups -- are worried about the chorus of complaints about Ginnie Maes.
Even Glenn R. Wilson Jr., the head of the Government National Mortgage Association -- which issues Ginnie Mae securities -- has joined the chorus of concern. At a recent securities industry meeting in Washington, Wilson criticized the wording of newspaper ads for the exotic investments that now are being sold like soap in late-night television commercials.
Growing objections to Ginnie Mae ads have focused on the failure of brokerage houses and mutual funds to explain how the claimed yields are calculated, how interest rate fluctuations can erode an investor's principal and why the Ginnie Maes contain special risks.
Government National Mortgage Association securities, backed by a portfolio of home mortgages, are sold to investors as "whole Ginnie Maes" for $25,000 each. Mutual funds create a pool of Ginnie Maes and sell small pieces to individual investors for as little as a few hundred dollars. Investments in Ginnie Mae funds have leaped from $4.4 billion on Jan. 31, 1985, to $19.7 billion on Jan. 31, 1986.
One of the least understood risks of Ginnie Mae funds came into sharp focus recently when interest rates plummeted and homeowners rushed to refinance their mortgages. When homeowners pay off their mortgages early, Ginnie Mae investors get their money back sooner, often earning less than they expected on their investments.
A variety of complaints from small investors about Ginnie Mae funds have been flowing regularly into the NASD in Washington, which operates the over-the-counter market and is the self-regulatory agency for the securities industry.
One investor recently wrote to the NASD, complaining, "I have contacted [my broker] to try to find out why I do not receive the interest on my reinvested Ginnie Maes. The broker informed me there were 30 other customers in his office in the same predicament."
In a recent speech to an NASD-sponsored meeting, GNMA's Wilson also voiced concern about the lack of federal control over more than 100 unregistered and unregulated dealers who trade in all government securities, including Ginnie Mae certificates. He described the government as "powerless" to police these dealers.
"For every investor who has been misled by an advertisement, another may have been taken advantage of by overzealous sales people and unfair sales techniques," Wilson said. "Still others have lost huge sums through the well-publicized collapse of outfits which are free to operate unfettered by the bounds by which NASD members conduct business . . . "
He noted that, in the last decade, 14 unregistered securities dealers have failed, causing $900 million in investor losses. One 1985 failure, that of ESM Government Securities, sparked the Ohio savings and loan crisis. Wilson called for "coordinated regulation of dealers in U.S. government securities."
The SEC has urged the mutual fund industry to "shape up" its advertising activities. Kathryn B. McGrath, director of the division of investment management, told industry representatives there are "growing feelings of concern and unease" in the agency. She said "the problem is your advertisements. Not all of them, but enough to make us wonder and worry, and conclude, like true regulators, that it is high time we tightened up on our rules. . . . We are convinced that something does need to be done, and soon."
Last month, Carolyn B. Lewis, assistant director of the SEC's office of disclosure policy and review, wrote to 56 Ginnie Mae mutual funds calling for changes in the prospectuses that funds are required to send investors.
Lewis complained that the funds put special stress, both in type size and in placement, on the U.S. government guarantee for the timely payment of principal and interest on Ginnie Mae certificates. At the same time, the funds "obscured" any cautions concerning "the fluctuations in yields and market prices of the securities and the fact and effect of early prepayments . . . " she said.
"We believe that prospectus disclosure and related advertisements which do not give equal weight and prominence to benefits and risks are misleading," Lewis wrote.
McGrath said that, as far as she knew, none of the mutual funds has yet responded to the letter. She noted that the SEC has the power to compel changes because each fund must apply for renewal of its registration each year.
McGrath said she hopes to see the funds "tone down" their emphasis on U.S. government guarantees because only the Ginnie Mae certificates, not the funds themselves, are guaranteed.
"If they take a hike to Brazil, the U.S. government will just say 'Sorry,' " she warned.
McGrath's complaints last fall sent the mutual fund industry rushing to devise ways to deal with the advertising problems of income mutual funds, including Ginnie Maes. Last week, after five months of study, the Investment Company Institute, which represents the mutual fund industry, delivered its recommendations to the SEC in a 33-page document. See accompanying story
A. Michael Lipper of Lipper Analytical Services of New York, a long-time mutual-fund watcher and analyst, said many investors simply do not understand the Ginnie Mae funds. "I don't think there is enormous risk in Ginnie Mae funds," he said. "There is some risk. Many people don't think there is any. There is a perception gap. These are investments, and people think they are guarantees."
Lipper found fault with ads that presented Ginnie Maes as alternatives to certificates of deposit or money market funds, which pay interest and do not affect the amount of principal. He added:
"In a period of declining yields, they are quoting historic yields." He said the effect was to encourage investors to project forward the quoted yields, as though they were promises for the future.
Industry uneasiness with the high-yield advertising for Ginnie Mae funds was reflected in a recent analysis by Robert T. Reeves, senior vice president of Ferris & Co., in Washington. In a paper titled, "GNMA's High Yields -- Fact or Fiction," Reeves wrote:
"High advertised yields often do not translate into the best return for investors. After considering such things as premiums, call features and other-than-normal income sources, it is important to ask, 'What is the real yield? Advertised yields are often the current returns on the money invested, and may differ significantly from the yield to maturity (or to average life.)
"In recent months, some investment firms have had aggressive marketing programs in GNMA securities, bond mutual funds and unit investment trusts highlighted by advertising that extols the attractiveness of high yields but not telling the whole story."
"Certain funds have resorted to selling options on the securities in their portfolios, or hedging their risk in the financial futures market in an effort to increase yield. Suddenly a conservative 'government bond' fund has taken on some speculative aspects. If the market doesn't cooperate, the yield could actually be reduced," Reeves said.
Some of the other quirks of Ginnie Mae funds were described by John G. Talty, senior fixed-income analyst at Merrill Lynch. Between Jan. 31, 1985, and Jan. 31, 1986, a Ginnie Mae with an 8 percent coupon delivered a total return of 27.7 percent. However, a 16 percent Ginnie Mae returned only 12.2 percent. He said the reason is that investors shun Ginnie Maes with higher coupons because their underlying mortgages will be prepaid sooner. That makes the lower-coupon Ginnies more valuable and raises their prices.