This article examines the performance of mortgage-backed securities (M
BS) mutual funds from January 1987 to June 1995. As a group, the MBS m
utual funds underperform both the Salomon and Lehman Brothers MBS mark
et benchmarks. The relative underperformance of the MBS mutual funds i
s due to poor securities selection and timing decisions. Fund expenses
also contribute significantly to the underperformance, while fund loa
d, turnover, management fees and other fund characteristics do not mat
erially affect performance. The underperformance is found to be concen
trated in several exceptionally bad months during the sample period. T
esting indicates that the MBS mutual funds underperform the MBS benchm
ark during months of rising interest rates, but match the MBS benchmar
k during months of failing interest rates.