Look Beyond Yield And Put Money To Work

Rates dropped significantly since January of 2011 and there is no compelling reason to invest anymore. Does this mean you should not put your money to work?

Many times the lack of a decision can be an emotional one. With very little compelling yield rationale to put money to work, investors feel they should wait until rates become slightly more attractive or loan demand increases.

Human nature or impulse jumps to quick judgment when you are looking at investment yields as low as they currently are. We procrastinate as the fear of loss or being wrong becomes a growing hurdle to overcome. Unfortunately with overnight rates below .25%, waiting is a very expensive strategy in contrast to the cost of funds.

As time goes on, the analytical side of your brain starts to digest the effects on your margins and you start to predict that rates have to quickly increase in order to offset the foregone income.

The decision to not invest is an implicit bet on rates and we are not in the business of betting on that. This bet has become somewhat more resolute in the face of the recent Fed action that indicated that rates may be in a fairly low channel for some time to come.

Those that have structured their balance sheets and investment portfolios for higher interest rates are on the wrong side one of the top trading and investment axioms of all-time: DON'T FIGHT THE FED. Those that have made a directional bet by staying too short on the curve and/or in cash while waiting for yields to go back up are fighting a five-year trend that shows no signs of abating.

By doing so, they have paid, and continue to pay, an enormous opportunity cost with ever-increasing reinvestment risk. Maturing investments are getting replaced at much lower yields than the original coupon, resulting in growing amounts of foregone interest income as the yield curve collapses year after year.


Coming To A Realization

Looking at the opportunity cost of waiting to invest, you begin to realize that it is very hard to make up earnings because of the explicit cost. However, there is also an implicit cost that those earnings affect your competitive posture in your core business. Those earnings could offset the deposit of loan pricing that may be the difference in success.

Market-timers rarely win because you can't beat the odds. However, you can set them more in your favor by having a regular and steady pattern of investing. Simply, diversity mitigates risk and gives the overall portfolio less volatility as well as more predictability and flexibility so that you are postured to react to changes in your core business.

There is no "one plan fits all" approach that will work. One should strive to structure an investment portfolio that is biased to the current market view, but designed to perform its duties in various scenarios.

What is an investor to do? The first order of business is to define your goals and start to develop a plan of action that starts with understanding your alternatives and agreeing to put a disciplined plan of investing in play. No one likes to go into battle without a well thought-out plan.

Growth is not a foregone conclusion. Even survival cannot be taken for granted. The credit unions that thrive in today's economy will be those that can shift their cultures from the slower pace of "business-as-usual" to one of urgency.

Remember that risk and reward go hand in hand. Unless you can "time" the market to buy and sell at the right time, something that not even Warren Buffett can consistently accomplish, you must accept some type of risk in the hope of growing your business. Over-concentration in any one asset class needs to be monitored and managed because it is through diversity that the risks are mitigated. Taking stock of your balance sheet is where the decision process starts.

We need to look beyond yield and try to see what role each investment plays so as to define the role the investment portfolio plays in your business model.


Investment Paralysis by Analysis

According to a study by the IBM Institute for Business Value, top-performing organizations use analytics five times more than low performers. Executives are always looking for better ways to communicate complex insights so they can quickly absorb the meaning and take action. This includes data visualization and process simulation.

Due to the increased regulatory scrutiny of every institution's risk-management process, it is prudent to utilize analytics as valuable tools to help measure, monitor and manage interest rate risk, liquidity risk, concentration risk and credit risk. It is easy enough to either create or outsource analytics; the key is how these are interpreted. Through this process, we have found that the most important aspect is to start doing the analysis with a strategic business direction or goal in mind.

If you don't question what you are trying to achieve by doing the analysis, we wind up bogged down in a state of "Paralysis by Analysis" and the effort becomes stalled. Many portfolio analytics on the market are a snap shot break down of the portfolio.


Investment Activation

When you're ready to take the insights from the portfolio analytics and transform them, what is the strategy? In general, as you finish up the year, take time to understand the various alternatives that are available to you and make sure you have both short and long-term strategies in place with achievable steps.

It is important to make sure that these steps are all within your comfort zone of risk tolerance and policy. This plan should not only incorporate an understanding of "what you are doing," it should also incorporate knowledge of "why you are doing what you are doing." Often times it is the latter point that serves to remove emotional or impulsive nature of some investment decisions and provides the necessary discipline to follow through on strategy; which means that a timetable has been thought through.

Michael Faughnan is managing director of Fixed Income Strategies, with First Empire Securities, Hauppauge, N.Y. For info: www.1empire.com.