Federal Reserve Governor Jeremy Stein’s concerns regarding a potential bond bubble were highlighted in a recent CNN Money article by Stephen Gandel.
“Stein says historically banks have tended to put their money in longer-term bonds, which have higher yields, when interest rates are low. And he sees some of that behavior today,” Gandel writes. “The problem is longer-term bonds tend to lose the most when interest rates rise.” The same trend can be seen, to a lesser extent, among credit unions.
As of December 31, 2012 credit unions held over $378 billion in investments — a 6.1% increase over the previous year. This signifies a reversal of the slowdown in investment growth within the industry that occurred in 2011 as the pace of loan growth began to pick-up significantly, while still falling shy of the 12.3% growth achieved from Dec. 2010 to Dec. 2011.
While nearly half of credit union investment portfolios are currently held in short-term investments (with durations of less than one-year), 23.9% are held in investments with maturities between three and 10 years and another 1.7% have maturities of over 10 years. These longer-term investments could experience price decreases at an inopportune time — as credit unions are beginning to see lending activities ramp up.
So how can credit unions manage investment portfolios that continue to increase while preparing for a potential bond bubble? Two investment alternatives that can help cooperatives take advantage of higher-yields without exposing themselves to longer-term interest rate risk are utilizing short or ultra-short duration mutual funds as part of their overall cash management strategy.
These types of investments can offer credit unions additional options for their overnight and cash portfolios by utilizing an enhanced cash strategy to gain yield without investing in individual securities with longer-term durations. Ultra-short duration funds typically include securities with maturities greater than one year and target a nine-month overall duration, while short duration funds target a two-year duration. Both can offer investors higher-yield potential than overnight or cash options, while remaining relatively short and providing same-day or next-day liquidity.
Whether or not a bond bubble is in our future, credit unions would be wise to take this opportunity to review their investment portfolios and evaluate potential risks. As loan demand continues to increase, having an investment strategy that provides for accessibility and liquidity could become a priority once again as credit unions focus on serving members’ financing needs.
About TRUST, Mutual Funds For and By Credit Unions
TRUST mutual funds options keep credit unions always invested, are professionally managed, and are based on the cooperative values of credit unions. The Ultra-Short Duration portfolio is one of three options available through TRUST. Callahan Financial Services, Inc., the distributor of TRUST, provides the resources and information credit unions need to support investment decisions. Contact us today to learn more or visit www.trustcu.com.
Mike Philbin is Vice President of National Sales for Callahan Financial Services, a subsidiary of Callahan & Associates that was founded to expand the investment alternatives available to credit unions. Mike is involved in both the marketing and sales functions for the Trust for Credit Unions.