Is it Time to Review Your Investment Strategy?
   
  By Kristina Muller, CFA, Senior Portfolio Manager, Balance Sheet Solutions, LLC

An investment strategy is different than an investment policy.
Has your credit union considered its investment strategy for the year? Let’s back-up a bit; did you have a documented investment strategy for last year? This is not your credit union’s investment policy, rather, it’s the strategy for your investment selections.
 
Every credit union should already have an established investment policy that sets portfolio guidelines. But an investment policy does not guide the investment decisions by taking current market conditions, or your credit union’s financial status, into consideration. That is why it is important to establish an investment strategy for the short-term goals of your credit union’s investment portfolio. 

Are you currently at low liquidity levels and require a greater amount of short-term investments? Or is it time to finally make some longer-term investments? While an investment strategy may incorporate many aspects of your investment policy, the strategy is actually the ‘action plan’ designed to reflect what steps your credit union will take to reach its near-term investment goals.

An investment strategy should also contain both the objectives and constraints of your credit union as an investing entity. Taking direction from the Chartered Financial Analyst (CFA) Body of Knowledge,1 the objectives can be stated in terms of risk and return, while the constraints discuss issues such as time horizon, unique circumstances, legal issues and liquidity levels. By reviewing these issues on a regular basis, your credit union can set realistic investment goals.

Risk
Every credit union is different; therefore, risk tolerances will vary greatly from one organization to the next. Some credit unions may take on risk through securities with embedded options or longer maturities. Others may prefer to keep all investments in highly liquid, short-term assets. One factor that may influence the amount of risk taken in your investment portfolio is the dependence on income generated from the portfolio. If your credit union is heavily dependent on portfolio income, then it may not be willing to take on a lot of risk. 

If your credit union’s portfolio is a secondary source of income, compared to loans for example, perhaps you are willing to take on some additional risk to achieve higher yields. In either situation, the preference of the credit union should be clearly stated in its portfolio strategy. Just as economic situations change, so can the preferred level of risk tolerance. By continuously reviewing your portfolio strategy, you can adjust your preferences to reflect the current status for your credit union.

Return
The return component of the portfolio strategy is dependent on your credit union’s risk preference, as noted above. Make sure the two components are in sync. If the investment strategy has stated that your credit union has a low risk tolerance, do not expect to achieve a high yield on your investment portfolio. Investors that take on a lot of risk expect to be compensated with higher returns. 

It is also important to be realistic about current market conditions. Make the return projections based on current interest rate levels. It is unrealistic to project a 7 percent return on an investment portfolio if the highest interest rate that can currently be achieved in the market is 5 percent. 

Time Horizon
Chances are that your credit union has established a maximum maturity for its investments. Does that mean that you want to invest that far out on the maturity curve at the current time? Due to the liquidity situation at your credit union, are you favoring short-term investments at the moment? A constraint like the time horizon in your investment policy is set to keep your entire portfolio within the limitations established by NCUA or your board of directors. However, you may want to set different maturity parameters in your investment strategy, depending on your credit union’s cash needs.

Unique Circumstances
If your credit union has any special situations that may impact the way its investments are made, this should be stated in your investment strategy. For example, if you are an education-based credit union, you may have cash shortfalls in the summer months. For this reason, your credit union may want to structure a larger amount of maturities during the summer to compensate for this cash shortfall. 
In addition, if current economic conditions have prevented your credit union from investing for the time being, this may be a good topic of discussion in your investment strategy as well. Be sure to note all of your credit union’s preferences in this written document. It is better to have too much information than not enough. 

Legal
It is also a good idea to remind those who review your credit union’s portfolio strategy of any NCUA guidelines or state laws that may affect investment decisions. You would not want to have something in your investment strategy that is not in line with NCUA, and with your state’s laws.

Liquidity
Liquidity is not just a measure of overnight funds in your credit union’s portfolio. It also focuses on the amount of short-term investments in its portfolio. Liquidity preferences are a variable that may be adjusted in your investment strategy from year to year, or as conditions warrant. 

If your credit union is concerned about near-term cash availability, you may want to increase the amount of overnight funds and short-term investments in its portfolio. However, maintaining a high level of short-term investments may cost your credit union in terms of yield. This is why the level of liquidity in your portfolio should be evaluated on a regular basis. It helps determine if the current strategy is appropriate. 

Asset Allocation Mix
Now that an investment strategy has been established, the next step is to determine the specific make-up of your investment portfolio. This is your asset allocation mix. It should take into account your permissible investment sectors, the strategy for the portfolio, and existing market conditions. 

Perhaps your current portfolio is heavily skewed towards bank CDs. You may want to increase your target allocations for Government Agency Securities or Corporate Credit Union CDs. Setting a target percentage weighting for your permissible investment sectors will help guide your investment purchases throughout the year. 

It is also important to remember to allow your portfolio the room to take advantage of various sectors throughout the year. Sectors can move out of favor at any time, and you’ll want to maintain the flexibility needed so you can invest in the most attractive areas when you are ready. 

Conclusion
A portfolio strategy is a useful tool to help your credit union realize goals for its investment portfolio. It is a dynamic document that can, and should, be adjusted based on market conditions and the conditions at your credit union. 

How do you know if your investment strategy is written correctly? A famous guideline is, “Could a complete stranger read your strategy and be able to work on your portfolio without any outside guidance?” If the answer is yes, then you have a well-written investment strategy.

While a written investment strategy may be a new concept to your credit union, it is highly recommended as an effective way to help your credit union reach its investment portfolio goals and objectives. 

1See www.cfainstitute.org.