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What Does SGAM Total Return Bond Fund Invest In? December 4, 2002
All you ever wanted to know about mortgage-backed securities are explained in this FAQ.
Author : SG Asset Management

Untitled Document


Question: Who are the targeted investors?

Answer: When mortgage-backed securities (MBS) are used in a diversified fixed income strategy, they typically comprise 25-50% of the portfolio. The Lehman Aggregate Bond Index is a commonly used US fixed income performance benchmark and MBS currently already comprise about 45% of this index. So, in a real sense, a benchmark neutral exposure to MBS is 45% of one�s portfolio! And since US MBS historically have had vastly higher Sharpe ratios than the other fixed income sectors, there are certainly other arguments for MBS to be considered as a standalone fixed income opportunity.

Q: Why is the S$ Units class hedged?

A: As the underlying fund (Sogelux Bonds - US Mortgage-Backed Securities Fund) which the SGAM Total Return Bond Fund feeds into is denominated in US$, the S$ Units class would be subject to fluctuations of the S$/U$ foreign exchange rate. In order to achieve the fund�s objective of providing consistent return to the investors over the investment horizon for both classes of Units, the S$ Units class will be hedged so as to protect the investors from the volatility of the foreign exchange market.

Q: What are the fees of the SGAM Total Return Bond Fund?

A: There is a 3% preliminary charge when investors buy into the fund. In addition, the total management fee of the fund will be 1% per annum, accrued weekly and chargeable to the fund on a monthly basis. The management fee is broken down into 0.60% per annum for the underlying level (which is the Sogelux Bonds - US Mortgage-Backed Securities Fund) and 0.40% per annum for the feeder level.

Q: Will there be extra costs involved by investing in a feeder fund structure?

A: No, there will not be extra layers of management fees involved by investing in a feeder structure. SG Asset Management has ensured that investors will be paying the same management fees if they invest into the Singapore fund or if they buy into the retail tranche of the underlying fund, the Sogelux Bonds - US Mortgage-Backed Securities Fund. This is made possible as the SGAM Total Return Bond Fund will be investing into the institutional tranche of the Sogelux MBS Fund which is denominated in US$. There will not be any subscription fees and redemption charges at the underlying fund level, except for the management fee which is 0.60% per annum.

Q: Why invest in US MBS?

A: Historically, US MBS have attractive returns and relatively low volatility as compared to other fixed income products. Secondly, MBS have had high Sharpe ratios historically, which means they have high returns relative to the risk taken, thus making it an attractive asset class for return enhancement. Thirdly, US MBS have historically outperformed US Treasuries when interest rates rise and with the global expectation for a rise in interest rates over the next few years, expectation for the US MBS market to outperform treasury (US government bonds) is high. Fourthly, US MBS is the most rapidly growing segment of the US fixed income market and has become the largest segment of the US fixed income market. It makes up more than 40% of the Lehman Aggregate Bond Index which is a widely used broad bond index in the US (as of end September 2002). Generally, the larger the market sector, the greater the number of product offerings. However, given the size of the US MBS market, there are surprisingly few specialised US MBS product offering. Hence the value-add for specialised MBS managers in creating excess returns for investors.

Q: Who issues US MBS?

A: The majority of US MBS are issued and/or guaranteed by an agency of the US government - the Government National Mortgage Association (Ginnie Mae) or by government-sponsored enterprises (GSEs) such as the Federal National Mortgage Association (Fannie Mae) and the Federal Home Loan Mortgage Corporation (Freddie Mac). These agencies buy qualified mortgage loans or guarantee pools of such loans originating from financial institutions, securitise these loans, and distribute the securities through the dealer community. They also provide different levels of guarantees to investors. Some private institutions also package various types of mortgage loans and pools - "private-label� MBS - in contrast to �agency� MBS.

Q: How safe are US MBS?

A: Issuers of US MBS are typically very selective in choosing the mortgages which make up their pools. Beyond the basic security of the mortgage-loans themselves, US MBS issued and/or guaranteed by Ginnie Mae, Fannie Mae and Freddie Mac carry additional guarantees which enhance their creditworthiness. The SGAM Total Return Bond Fund will mainly invest in high quality US MBS guaranteed by the US government, its agencies, instrumentalities or its sponsored corporations, and in privately issued mortgage-backed securities rated Aa or higher by Moody's or AA or higher by Standard and Poor's.

Q: What are the risks involved?

A: Investment in US MBS is subject to credit risk where some issuers may be unable to meet their financial obligations, such as the payment of principal and/or interest on an instrument, or go bankrupt. Furthermore, an issuer may suffer adverse changes in its financial condition that could lower the credit quality of a security, leading to greater volatility in the price of the security and in the value of US MBS. A change in the quality rating of a bond or other security can also affect the security's liquidity and make it more difficult to sell.

Investment in mortgage-backed securities which are not guaranteed by the US government, which may make investors subject to certain credit risks. This is especially true during periods of economic uncertainty or during economic downturns.

Investment in US MBS may be subjected to interest rate risks where the value of the mortgage-backed securities may fall as fixed income securities generally fall in value when interest rates rise. The longer the term of a fixed income instrument, the more sensitive it will be to fluctuations in value from interest rate changes. Changes in interest rates may have a significant effect on US MBS, especially securities with a long term to maturity and mortgage-backed securities, including collateralised mortgage obligations, and stripped mortgage securities. Such holdings of mortgage-backed securities can reduce returns if the owners of the underlying mortgages pay off their mortgages sooner than anticipated when interest rates go down. With investments in mortgage-backed securities, it may be subject to extension risk and prepayment risk, which are both a type of interest rate risk.

"Extension risk" refers to the possibility that rising interest rates may cause owners of the underlying mortgages to pay off their mortgages at a slower than expected rate. This particular risk may effectively change a security which was considered short or intermediate term into a long-term security. Long-term securities generally drop in value more dramatically in response to rising interest rates than short or intermediate-term securities.

"Prepayment risk" refers to the possibility that falling interest rates may cause owners of the underlying mortgages to pay off their mortgages at a faster than expected rate. This tends to reduce returns since the prepayment will have to be reinvested at the then lower prevailing rates.

Investment in US MBS is also subject to liquidity risk with the possibility that the investors may lose money or be prevented from earning capital gains if the mortgage-backed security cannot be sold at the time and price that is most beneficial to the investors. Because mortgage-backed securities may be less liquid than other securities, investment in US MBS may be more susceptible to liquidity risks than funds that invest in other securities.

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The prospectus for the SGAM Total Return Bond Fund (the "Fund") is available and may be obtained, subject to availability from the distributors. Investors should read the prospectus before deciding whether to subscribe for or purchase units in the Fund ("Units"). The value of the Units and the income accruing to the Units may fall or rise. The past performance and/or any forecast is not necessarily indicative of the future or likely performance of the Fund or SGY Asset Management (Singapore) Limited (the "Manager").Units are not bank obligations of, or guaranteed or insured by the Manager, or any subsidiaries or associated companies of the Manager or by the distributors or any of their affiliates or subsidiaries. An investment in Units is subject to investment risks, including the possible loss of the principal amount invested, Units are not available to US persons.


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