High-Yield Twins

Agency bonds are as safe as Treasuries, yet offer more kick

There are few things as secure as Treasury bonds. Named after the department in Washington that issues them, they’re backed by the most trustworthy borrower of all time–the U.S. government. To sweeten the deal, the interest they pay has flirted with as much as 7% several times this year. So how do you beat that?

The answer: by buying government agency debt. Over the years, as the federal budget deficit has expanded, a host of bureaucratic outfits– ranging from the Federal Home Loan Mortgage Corp. (Freddie Mac) and the Federal National Mortgage Association (Fannie Mae), which might have helped you get your first home, to the U.S. Postal Service–have issued bonds. Like Treasuries, agency bonds pay interest every six months and have virtually no credit risk. Washington implicitly stands behind the debt obligations of various government agencies and, as you probably know, Uncle Sam has yet to default. The rating on all agency debt is virtually risk-free. “Except in inflationary times, if you want absolute safety of your principal, this is what you invest in,” says Jarius DeWalt, a vice president at M. R. Beal & Co. in New York.

Wall Street pros also love the fact that agency bonds give you a bit more zip for the buck. As of late June, five-year Treasuries were yielding 6.38%, whereas non-callable five-year agency debt paid about 6.62%. Agency bonds maturing in 10 years were yielding 7.5%, while 15- year agency debt yielded 7.75%.

So how do you get your money into government agencies? There are two methods: you can buy them directly through an investment bank or brokerage firm, or you can invest in a mutual fund that targets agencies. The catch with individual agency bonds is the amount you have to scrape together–around $5,000, says George Benigno, an analyst at the Institute for Econometric Research in Deerfield Beach, Florida. Agencies are also a bit more difficult to trade than Treasury bonds because the market for them is small.

With that in mind,it may be best to invest in individual agency bonds as a substitute for Treasuries when you’re looking to preserve a certain amount of savings for a specific target, such as college or retirement. Ask your broker to price both an agency bond and a comparable Treasury, and factor in the brokerage fees in both cases when comparing yields.

Also consider the tax implications of investing in government securities. “Fannie Mae and Freddie Mac are taxed at the local, state and federal levels,” says Joan Rusch, a managing director and trader at Lebenthal & Co. in New York. At the same time, interest on bonds issued from other agencies–including the Federal Home Loan Bank, the Student Loan Mortgage Association (Sallie Mae), the Tennessee Valley Authority and the Federal Farm Credit Bank–is generally not subject to city and state tax. This can make a big difference in states such as New York and California where local rates are high.

If, as an individual investor, you haven’t a few thousand to invest, your easiest access to

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