Agency debt refers to debt securities issued by government-sponsored entities (GSEs) or federal agencies. The government creates these entities to fulfill specific purposes such as providing funding for housing, education, or agriculture. Examples of GSEs include Fannie Mae, Freddie Mac, and the Federal Home Loan Banks.

Characteristics of Agency Debt

• Government Backing: One of the key features of agency debt is the implicit or explicit guarantee provided by the U.S. government. Although the government does not directly back it with its full faith and credit, investors perceive it as a lower risk compared to other types of debt.
• Yield and Maturity: Agency debt typically offers higher yields compared to U.S. Treasury securities with similar maturities. The yield advantage reflects the perceived credit risk associated with these securities. Maturities can range from short-term to long-term, providing investors with a variety of options to suit their investment goals.
• Liquidity: It generally remains highly liquid, meaning that buyers and sellers can easily trade it in the secondary market. This liquidity makes this type of debt an attractive investment option for investors who value flexibility and the ability to access their funds when needed.

Why Invest in Agency Debt?

• Diversification: Including it in your municipal bond portfolio can help diversify your investment holdings. By adding these securities, you can reduce the concentration risk associated with holding only municipal bonds issued by state and local governments.
• Stability: Investors consider this kind of debt relatively stable due to the government backing and the essential services the GSEs provide. This stability can be particularly appealing to conservative investors who prioritize capital preservation.
• Income Generation: The higher yields offered by this debt can contribute to income generation for investors. This can be especially beneficial in a low-interest-rate environment where finding attractive yields is challenging.
• Risk Management: Agency debt can serve as a risk management tool for investors. By strategically allocating a portion of your portfolio to it, you can balance the risk-reward trade-off and potentially mitigate the impact of market fluctuations.

Types

• Mortgage-backed Securities (MBS): These are debt securities that represent a claim on the cash flows generated by a pool of mortgage loans. GSEs such as Fannie Mae and Freddie Mac are the largest issuers of MBS. Investing in MBS can provide exposure to the housing market.
• Collateralized Mortgage Obligations (CMOs): CMOs are a type of MBS that have been divided into different classes, called tranches, based on their risk and return characteristics. Each tranche has a different priority of receiving cash flows from the underlying mortgages.
• Asset-backed Securities (ABS): ABS are debt securities backed by a pool of assets like auto loans, credit card receivables, or student loans. GSEs like Sallie Mae issue ABS to support education financing. Investing in ABS can offer diversification beyond traditional bond markets.
• Student Loan Securities: As the name suggests, these securities are backed by a pool of student loans. Entities like the Student Loan Marketing Association (SLMA), also known as Sallie Mae, issue them. Investing in student loan securities can provide exposure to the education sector.
• Farm Credit System (FCS) Debt: FCS debt consists of bonds and notes issued by the Farm Credit System, which provides financing to agriculture-related businesses and farmers. These securities support the agricultural sector and can offer investment opportunities tied to this specific industry.
• Federal Agency Debt: This category includes debt issued directly by federal agencies such as the Small Business Administration (SBA) or the Government National Mortgage Association (GNMA or Ginnie Mae). These securities play a role in funding specific government initiatives.

Agency debt is an important component of the municipal bond market, offering investors a range of benefits such as diversification, stability, income generation, and risk management. Understanding the characteristics and advantages of it can help you make informed investment decisions and optimize your portfolio. As always, consult with a financial advisor to determine the suitability of agency debt within your overall investment strategy.

This commentary is not a recommendation to buy or sell a specific security. The content is not intended to be legal, tax or financial advice. Please consult a legal, tax or financial professional for information specific to your individual situation. Investing involves risk including possible loss of principal. Past performance is no guarantee of future results. Diversification does not guarantee a profit or protect against Not all annuities are available in all states. Surrender charges may apply to withdrawals during the surrender period. A 10% IRS penalty may apply to withdrawals prior to age 59 ½. Annuity product guarantees rely on the financial strength and claims-paying ability of the issuing insurer. Annuities are not guaranteed by any bank or credit union and are not insured by the FDIC or any other federal government agency.