Bank investment portfolios are an important part of managing the balance sheets of financial institutions. However, the growing risk associated with carrying too much cash on balance sheets has forced many executive teams to rethink how they manage these portfolios. There are two main options for banks that can help them improve the quality of their investment portfolios.
Before deciding on an investment portfolio, bank executives should understand the institution’s asset/liability sensitivity, as well as the composition of its balance sheet. This information will help them determine the right type of asset to hold. For example, if a bank has a large number of variable rate loans, it could reposition its investment portfolio by increasing its duration and buying call-protected bonds. This would reduce interest rate risk and prepayment risk.
A strong investment portfolio and balance sheet are critical during times of economic uncertainty. Banks that are well-capitalized and maintain a healthy balance sheet are essential to investors. However, they should be aware of the risks associated with these assets, because these investments are not insured by the FDIC. As with any investment, the value of these assets may decrease. Fortunately, bank investment portfolios are increasingly diversified. These investments can provide a secure environment for executing transactions and managing their value.
While some banks make prudent investments, others make mistakes that can lead to increased risk and loss. In particular, some banks make the mistake of focusing their portfolios on single asset classes, rather than evaluating a broad range of investment opportunities. They miss opportunities to improve yield or manage risk by concentrating their portfolios in a narrow sector.
Some larger institutions choose to employ a core-satellite approach, whereby they manage their core assets while hiring a third-party manager for their satellite strategies. These strategies include corporate credit, municipals, and commercial mortgage-backed securities. However, the third-party manager must provide the necessary tools for the bank to monitor their investments.
In addition to an independent investment advisor, banks may work with brokers. These intermediaries help bank executives make important strategic decisions and allocate their money accordingly. By acting as a partner and co-managing the portfolio, independent investment advisors free bank executives from time-consuming tasks. They are also accountable to their clients and aligned with the institution’s objectives.
For investors who need their money within a few years, a conservative portfolio may be more appropriate. A conservative portfolio will help them avoid market downturns and maximize their savings. If, on the other hand, they do not need their money for decades, they may opt to invest all their money in stocks. The risk factor in such cases is low, and it is possible to ride out the volatility of the market.
Diversification is important for all types of portfolios. Asset allocation should reflect the investor’s risk tolerance, return objectives, time horizon, and other relevant constraints such as tax, liquidity, and legal situations. In addition to diversifying the portfolio, careful consideration must be taken to ensure the appropriate balance.