If you think about it, managing a bank’s bond portfolio is very much like managing a bond mutual fund. Let’s explore current bank bond portfolio performance metrics using the language of bond funds.
Alpha is a term used by bond fund managers that measures the performance advantage a fund achieves over an industry benchmark. In other words, alpha is why you would select a particular managed fund over simply investing in an index (or non-managed) fund.
For a bank, alpha could be defined as the additional performance one achieves versus a broad bank peer group. We use the UMB Peer Group as the benchmark as it contains approximately 600 diverse bank bond portfolios, located throughout the United States. The returns of the this group tend to mirror the widely recognized Uniform Bank Performance Reports.
The chart at this link breaks down the top 10 percent, average and bottom 10 percent of the UMB Peer Group.*
The final step is quantifying the alpha (or annualized advantage/disadvantage) for your portfolio in dollars versus peers. To do this, multiply the book value in securities you hold by both the difference between your current yield and 3.14 percent for current income, and your total return and 5.27 percent for potential future income. These two dollar figures represent either the income/total return advantage you possess currently over peers or the income/total return opportunity possible in the future if your bond portfolio’s performance would equal your peers. You can also run your numbers versus the top 10 percent as well. If you need any help with this process or in interpreting the results, feel free to email me.
It is important to note that every bank is different in terms of its loans and securities mix, capital position, interest rate risk, liquidity and pledging needs, and overall philosophy on the role of its investment portfolio. There may be sound reasons for your portfolio being different from your peers, as every bank is unique and your bond portfolio, accordingly, should be customized to your goals and particular risk profile.
In my opinion, now would not be a good time to stretch for additional alpha or make significant changes in your portfolio strategy … although it is very tempting.
Jeff Goble is executive vice president and managing director, investment banking, at UMB Bank, n.a., Kansas City. His email address is Jeffrey.Goble(at)umb.com.
Copyright (c) March 2012 by BankNews Media