(FORTUNE Magazine) – Investors now have the right to bear ARMs. Not those that fire, those that yield. Adjustable-rate mortgages (ARMs) have recently become an investment vehicle widely available to small investors through a handful of new mutual funds. These ARM funds offer shareholders more bang for the buck than bank accounts, CDs, or money market funds, though they also come with a tad more risk. The ARM funds invest at least 65% of their assets in adjustable-rate mortgages, usually those issued or guaranteed by a U.S. government agency, such as the Government National Mortgage Association (Ginnie Mae). These agencies buy the mortgages from banks or thrifts and package them into securities, which the ARM funds buy.

Though the fund yields vary depending on the mortgages in their portfolio, an average adjustable mortgage yield would range from one to 2.5 percentage points more than the average money market fund, depending on market conditions (see chart). Right now, for instance, the largest and oldest ARM fund, Franklin Adjustable U.S. Government Securities fund of San Mateo, California, yields 7%, vs. 5% for the average money fund. The extra dollop of yield brings a commensurate increase in risk. For example, the yield on ARM funds moves up and down with prevailing interest rate trends, but it lags, reflecting periodic adjustments in the rates paid on the mortgages. Because of this, the net asset value (NAV) of an ARM fund can fluctuate, whereas a money market fund's will not. The Franklin fund went public in October 1987 at $10 a share. Since then its NAV has ranged from $10.31 to $9.92. If you had bought at the top and sold at the bottom, you would have lost 3.78% of principal -- far from devastating, but a loss nonetheless. Capital losses could be worse if interest rates spurt back into double digits. Because adjustable-rate mortgages have interest rate caps, an ARM fund's yield will eventually stall out if interest rates fly high enough, and that would send the NAV tumbling. An ARM issued at today's prevailing rates, say 7.5%, might have an interest rate cap of 12.5%. We're far from those rates now, but times change. Another risk is that the popularity of these new funds could undermine their performance. Says Don Phillips of Morningstar, a fund rating service in Chicago: ''We are seeing increasing demand for ARMs from new mutual funds, while at the same time, the supply is tightening as homeowners move from adjustable- to fixed-rate mortgages to lock in low rates.'' The resulting squeeze, he notes, could force ARM yields down closer to money funds. But Stephen Brown, co-manager of the Benham Capital Management Adjustable Rate Government Securities fund in Mountain View, California, thinks this risk is small. Says he: ''There are still plenty of ARMs available. I look at 50 pools of mortgages before I buy one.'' When searching for an ARM fund, you should consider several factors beyond current yield. Chief among them is the sales charge, since a hefty load can dramatically lower your return, especially if your stay in the fund is short term. The Benham and the T. Rowe Price Adjustable Rate U.S. Government fund carry no load, which makes them particularly attractive. Putnam, on the other hand, charges a sales load of 4.75%, then encourages investors to move money in and out by using the check-writing privileges the fund offers. You get one opportunity to redeposit money without paying a load, but beyond that you get zapped by the load charge each time you put money back in. Another bit of fine print worth checking out is the percentage of fund assets that are in securities backed by the government or government agencies. Some funds will go for higher yields by holding mortgages that don't enjoy any federal backing. This exposes them to default risk, which could lower your return should the economy turn back down. Pilgrim Adjustable U.S. Government Securities fund, for example, has 30% of its assets uninsured, while T. Rowe Price's fund has 25% in such fare. The other funds listed in the table on the preceding page are all fully invested in government- or government-agency- insured securities.

CHART: NOT AVAILABLE CREDIT: JEAN HELD FOR FORTUNE Source: Federal Home Loan Mortgage Corp. Source: IBC/Donohue. CAPTION: A NEW HOME FOR YOUR MONEY ARMs VS. MONEY FUNDS ARM FUNDS