The Credit Supernova

The current debt in the U.S. causes many investors to take on more risk; is it worth it?

 
 

In a February research note put out by Bill Gross at PIMCO, he writes about the “Credit Supernova,” the Catch-22 debt situation of the U.S., where interest on the national debt is suppressing the economic growth that the debt was intended to create. The amount of debt currently incurred by the US is greater than $52 billion, leaving the country with debilitating debt payments. High debt coupled with near-zero interest rates is having profound impacts—from tighter margins at financial institutions, to forcing the hand of insurance companies to fund their reserves, to underfunding pension programs. These low rates and tighter margins caused many investors to take on more risk: extend duration, invest in a new asset class with variable cash flows, or take-on additional credit risk.

Many credit unions don’t take risks on their investment portfolio. It is designed to be a tool where active management can provide liquidity, manage balance sheet duration, and provide low-risk income.

Earlier this week, I was part of a product-development meeting with Goldman Sachs Asset Management, the advisor to the Trust for Credit Unions Mutual Funds. We discussed types of product we could design to help credit unions better manage excess liquidity. Our discussions touched on new structures, new asset classes—including longer duration securities—and risk mitigation tools. The fundamental question we kept coming back to: Is the added risk worth it?

Portfolio managers in all sectors are balancing the same question, is the risk worth it? Who would have ever thought five-year treasuries would yield less than 1% and that the 10-year is less than 2%. Investors around the world are wondering, is it worth doubling the duration to double the yield? In most environments, the easy answer is yes. Today, because of the absolute low rate environment—and the potential for inflation caused by the massive debts, the answer may be no.

So what do you do? Balance and diversification are key. Managers should be prepared for the future, but at the end of the day credit unions are in the business of risk-management, not risk-avoidance.

 
 

Feb. 8, 2013


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