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This Time It’s (not) Different

By: Chris Thompson & Josh Kiefer

The story goes like this: A trio of renowned investors chartered a small plane to take them on an annual hunting trip to the heart of Alaska where they each hoped to bag a world-class moose. After landing, as they embarked on their hunt, the pilot warned them, “Don’t forget, this plane is only big enough for one moose.”

The hunt was a tremendous success. Each investor shot a bull moose and none of them wanted to leave their kill behind. On returning to the plane, they persuaded their pilot to allow them to board all three trophy moose.

Just after takeoff, the small craft, overloaded and unresponsive, stalled and crashed. The pilot and one of the investors perished in the fiery remains. The two surviving investors crawled out of the wreckage, looked at each other, and one said to the other “Where the heck are we?” His surviving friend replied, “Oh, about a mile south of where we crashed last year.”

Moral of the story: Safety first, trophies last and learn from the past … all of which is excellent advice for bank bond portfolio managers attempting to navigate the turbulent skies of the current investment climate.

Safety First

More than ever, liquidity is paramount. With problem assets as a percentage of total assets gaining on a national scale, liquidity rules the roost. In this weakened economic state, retail depositors are nervous and likely to do one of two things: 1) bring you more deposits because they fear for their dollars elsewhere; or 2) move their funds for a better rate or a better safe haven outside your bank. In either case, you will need ready and identifiable liquidity.

There is no better tool in your liquidity toolkit than ordinary (perhaps old-fashioned) bonds. They are stodgy, not sexy … and that is why they’re attractive. You will have a ready audience willing to bid for these decidedly boring bonds precisely because everybody knows exactly what they are: plain vanilla, no sharp edges and easily traded.

Trophies Last

This is not the time to swing for the fences; those who do rarely achieve their aim (see: private label mortgages, CLOs, SIVs, CDOs and other varieties of “kitchen sink bond” investors). In times like these strong balance sheets and brighter futures are owned by those who remember that discretion truly is the better part of valor. Reaching for yield in the bond portfolio, at this stage in the game in particular, is a formula for disaster. The curve is steep, yields are historically low and the unprecedented liquidity measures from the Fed are likely to (eventually) stoke inflationary embers and lead to a devastating inferno.

Humorist and philosopher Will Rogers’ observation that “the return OF my money is more important than the return ON my money” addresses today’s investment landscape well. For a contemporary view, consider the case of PIMCO’s Bill Gross. Gross is the highest paid and most prolific manager of fixed income on the planet. On Dec. 11 he was interviewed by Kathleen Hays of Bloomberg TV. With his flagship Total Return Fund posting less than impressive returns, she asked him what he most regrets. His answer: “If we went back 12 months and we had known then what we know now, it would have been all invested in Treasuries.” Thus, Gross proves the rule that experience is the name most people give to their mistakes. Skip the trophy, hit singles, get on base and score.

Learn From the Past

Who remembers 2003? A faltering economy, steep yield curve, historically low rates, 1 percent fed funds target, 4 percent prime rate, depressed earnings and pressure on the portfolio to increase income. Sound familiar? But some may protest, “This time it really is different!” Unlike 2003, today’s spreads on agency debt are triple digits, we’re in a global recession, GDP is trending negative, bank failures have multiplied and the U.S. auto industry is on life support.

True … but none of these singular factors can resist the cyclic reality of investing. High rates beget low rates, low rates beget high rates. Precisely when the tide will turn is impossible to know. But when it turns, it moves fast and the undertow is vicious.

Chris Thompson is executive vice president and Josh Kiefer is investment officer at Country Club Bank, Prairie Village, Kan.

Copyright © January 2009 BankNews Publications


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