What is the primary risk associated with investing in a Government National Mortgage Association (GNMA) fund during a period of falling interest rates?

The primary risk associated with investing in a Government National Mortgage Association (GNMA) fund during a period of falling interest rates is reinvestment risk. This risk arises when the interest payments or principal repayments from the mortgage-backed securities within the GNMA fund are received and must be reinvested at lower prevailing interest rates.

In a declining interest rate environment, as mortgages are refinanced at lower rates, the cash flows coming into the GNMA fund can be significantly reduced. Investors are then faced with the challenge of reinvesting these cash flows at yields that are typically less attractive than the original investments. This can lead to a lower overall return on the investment, as the investor may have to settle for lower interest rates when reinvesting the cash received from principal paydowns and interest payments.

This is particularly important for a GNMA fund, as it is heavily influenced by changes in mortgage rates due to the nature of its underlying assets, which are government-insured mortgage loans. As such, understanding reinvestment risk allows investors to plan for the impact of interest rate movements on the overall performance of their investments.