ABA Banking Journal - November/December 2015 - (Page 20)
> INVESTOR PERSPECTIVE
Is Your Investment Portfolio
Prepared for Higher Rates?
BY STEVE TWERSKY
GIVEN THE EXPECTATIONS for higher rates as the Federal Reserve tightens,
that's a question you've likely thought about. But a better question may be:
"Is your portfolio prepared for the coming shift in the yield curve?" Market
rates along the curve rarely move in a parallel fashion, and the change in the
slope of the curve can be just as important as the actual change in rates.
History has shown us the curve
typically flattens sharply as the Fed
raises short rates. Table 1 shows the
change in the 10-year Treasury yield
between the first and last Fed move
for the last two tightening periods.
So what's the best strategy to
address this coming flattening? From
a pure total return or economic
value standpoint, some variation of a
barbell approach would be optimal.
Shorter cash flows are important to
Note the very modest change in longer
yields. It's also noteworthy that in
both instances, the funds target rate
exceeded the yield of the 10-year
by the time the Fed made its last
move-resulting in inverted curves.
be able to reinvest at higher rates as
the short end of the curve pushes
higher. But longer bonds also do
very well, as the current steepness
allows for the capture of needed
higher yields with limited projected
losses as the curve flattens.
There is every reason to believe the
current tightening will play out in
a similar fashion. Without broad,
sustained economic growth, there
is little to pressure longer term rates
to move much higher. Indeed, if
the Fed raises the short end too
fast or too much, it risks laying a
foundation for the next recession and
thus pushing longer rates lower.
ABA BANKING JOURNAL | NOVEMBER/DECEMBER 2015
But bank portfolio managers have
to consider much more than simply
the best place to be on the curve.
The repricing and liquidity needs
of the entire balance sheet must
also be considered. And those
seeing increases in loan demand
need to make certain liquidity is
readily available for funding.
We would take a balanced
approach right now:
* Make certain the portfolio maintains
a good degree of roll-off over the next
five years, even as rates rise.
* To provide balance to this short
focus, target some degree of callprotected, longer-term bonds. The
higher level of absolute yields in
longer bonds is needed to keep
margins from declining as deposit
rates begin to push higher. These
longer bonds will also help you
maintain a higher overall yield should
the Fed moves shut down enough
economic growth to cause longerterm yields to fall. The tax-exempt
municipal market provides one of the
best sectors for banks to accomplish
this, given the steep slope of the
curve as well as the extended call
With the strong likelihood that the Fed
will continue to ratchet short rates
higher for the near term, it's hard to
fight the temptation to keep funds very
short to invest later at higher yields.
We think a more balanced approach is
needed-one that targets some degree
of longer bonds to allow you to optimize
yields now, benefit from continued
flattening in the curve and protect
against an economic downturn.
STEVE TWERSKY is EVP
and manager of the portfolio
strategies group at FTN
Financial, Memphis, Tenn.
Table of Contents for the Digital Edition of ABA Banking Journal - November/December 2015
A Conversation With the Comptroller
Cover Story Doing the Right Thing
Big Data and Predictive Analytics: A Big Deal, Indeed
Stress Testing: Feeling the Pressure?
ABA Compliance Center Inbox
Cybersecurity Self-Assessment Tool Helps Combat Risk
Real Estate Lending
Banker Recommended Reading
From the States
Corporate Social Responsibility
Index of Advertisers
ABA Banking Journal - November/December 2015