Meier: Contraction or extension risk can lead to a potential asset-liability mismatch.

Take a Balanced Investment Approach

Edward Meier suggests managing a blend of short- and long-term investments to guard against unexpected market movements.

He’s a portfolio manager in the Fixed Income Division of MEMBERS Capital Advisors, the registered investment advisor affiliate of CUNA Mutual Group, Madison, Wis.

CU Mag: How should CUs adjust their investment portfolios as the economy slowly improves?

Meier: Assuming rising interest rates, I would expect a gradual move by credit unions to hold less cash-equivalent vehicles and more intermediate and long investments. I will be recommending investments with higher yields and slightly adding to the duration of the portfolio.

CU Mag: What short- and long-term investment vehicles favor this environment?

Meier: I believe in a balanced approach to portfolio management. Managing a blend of short- and long-term investments protects against unexpected market movements. Core positions of callable and step-up agencies with some longer duration investments (i.e., mortgage-backed security pass-throughs or corporate credit) are essential to my strategy.

CU Mag: Which short- and long-term investment vehicles should CUs avoid in this environment?

Meier: Be cautious of any security with extreme negative convexity. An example would be certain mortgage-backed securities. Right now yields look attractive, but prepayments have been forecast to be very fast.This will shorten the average lives of these securities and make them look more attractive than they really are. Trouble arises once the current environment changes. Prepayments can quickly slow down or speed up, and this will extend or contract the average lives of these mortgage-backed securities.

Contraction or extension risk can lead to a potential asset-liability mismatch or even negative yields. Therefore, meticulous analysis should be done on any security with negative convexity. Just ask someone who owned collateralized mortgage obligations (CMO) in 2003 or the early 1990s.

CU Mag: What investment instruments have been most appealing to your CU clients in recent months?

Meier: Short to intermediate callable agencies with intermediate lock-outs still offer value. I would even look to layer on agency structured notes with intermediate calls and coupon step-ups.

Actively managed CD programs appear attractive. All three investments provide flexibility to reinvest near-term and incremental yield. It’s a tough time to find value, but this is why you have to have both a short- and long-term approach to managing your portfolio. You may give up incremental yield today for the flexibility to invest at higher rates tomorrow.

CU Mag: What advice do you offer CUs regarding investment portfolio management in an improving economy?

Meier: Managing your portfolio requires a disciplined approach, especially when interest rates are at historic lows. Exercising a short- and long-term investment strategy will guide you when you are tempted to add risk.

Active management doesn’t mean reaching for yield. Many investors have locked themselves into bad long-term investments when adding yield.

Also, focus on investment timing as the economy starts to recover and interest rates rise for the first several sessions. Plan out how you’ll reinvest. Be prudent and have a strategy.

Finally, don’t be afraid to ask for help. Investment advisors are willing and able to offer their expertise.

Edward Meier is a portfolio manager in the Fixed Income Division of MEMBERS Capital Advisors, the registered investment advisor affiliate of CUNA Mutual Group, Madison, Wis. Contact him at 800-356-2644, ext. 7184.