For the most part, credit unions across the nation use their investment portfolios as a secondary income generator to their loan portfolios. And while credit unions are in the business of providing loans at low rates and offering high deposit rates, they often neglect the fact that the more they can squeeze out of their investment portfolio, the more they can give back to their members in the form of lower loan rates and higher deposit rates. A classic example is the buy-and-hold strategy most credit unions employ when it comes to their investment portfolios.
In a buy-and-hold portfolio, the market yield at the time of purchase is the expected yield to maturity. That is, when a buy-and-hold investor buys a security, s/he expects to receive the market yield until the security matures and is paid back. Between the time of purchase and the maturity, a buy-and-hold investor ignores the unrealized gain/loss in the portfolio and does not look to take advantage of repositioning the portfolio when market expectations change.
Unlike a buy-and-hold portfolio, a portfolio managed from a total-return perspective will consider the unrealized gain/loss as part of the portfolio's performance, in addition to the yield. By doing so, the total-return investor can achieve far greater returns than that of a buy-and-hold investor simply by taking the gains or losses and reinvesting the proceeds to realize a higher effective yield, which can then be used to complement other parts of the balance sheet.
Let's imagine credit union “Example FCU” purchases a five-year corporate certificate on May 1, 2005 (three years ago) with a yield of 5.20 percent. The current rate, as of May 1, 2008 , on a two-year corporate certificate (now the remaining term on the corporate certificate) is 3.00 percent. The buy-and-hold investor, who does not keep updated on current market rates, will receive 5.20 percent for the next two years until maturity. However, the total-return investor, who stays updated on current rates, will look at the current redemption value and realize that the security has a 4-point premium (a 104 market price). To the total-return investor, this means if the credit union were to redeem the security, it would actually have a yield of 9.20 percent (5.20 percent + 4 percent = 9.20 percent). Next, the investor only has to find a security that, when combined with the “gain from the sale,” has a net yield greater than 5.20 percent for the remaining two years.
To break even in this example, the investor would have to find an investment yielding only 3.20 percent (see chart below). In fact, at the time of writing, yields in the range of 3.50 percent-4.50 percent could be purchased on implied government guaranteed debt. While this is not always possible, and each trade should be examined on a case-by-case basis, we can see that in a total-return portfolio excess income can be generated over a buy-and-hold portfolio.
When planning your portfolio investment strategies, keep your members top of mind. Remember that every incremental dollar that can be earned from your investment portfolio is more money that can be distributed back to your membership either through lower loan yields, higher deposit rates, or even a cash dividend.
For more information on investment strategies for your credit union's portfolio, please contact ALM First Financial Advisors, (800) 752-4628, or visit www.almfirst.com.
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