Agency bonds are issued by government corporations like Ginnie Mae or government-sponsored enterprises like Fannie Mae. The money raised is generally used to finance mortgages.
Upside: Their relationship to the federal government means agency bonds are nearly as secure as Treasuries. That's especially true since the federal government placed Fannie Mae and Freddie Mac, two of the largest issuers of agency bonds, under federal conservatorship control in 2008.
However, because they aren't explicitly backed by the full faith and credit of the U.S. government, agency bonds offer higher interest rates.
Downside: The duration of many agency bonds can be sensitive to interest-rate changes. That's because when interest rates fall, agency bonds are likely to be called, or redeemed, early by refinancing homeowners, robbing investors of potential yield. Conversely, when interest rates rise, homeowners hang on to their mortgages longer, locking investors into a relatively low rate and hurting bond prices.
Bottom line: Relatively low credit risk and higher interest rates than Treasuries can make agency bonds a good investment, Richelson says.
However, because high inflation is often accompanied by rising interest rates, the sensitivity of mortgage-backed agency bonds to interest rate changes could make them a poor hedge against inflation.