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The Power Of Total Return For Balance Sheet Management

Tracking total return provides multiple insights for ongoing asset and liability management and investment options.

Credit unions typically make pricing and investing decisions using >yield as the single performance indicator. Yield is the amount earned and booked from anearning asset or the amount paid on savings. This is how credit unions recognize income and record cost of funds, also called funding liabilities.

The chart below illustrates this measure of investment performance using four credit union segments over the past five years.

Yield On Average Investments
For All U.S. Credit Unions and Three Selected Peer Groups, 2006-2011
Source: Callahan & Associates’ Peer-to-Peer Software. | Click to view larger.

These lines, however, do not provide the full economic profile of the total performance of these portfolios. In cases such as these, total return more accurately reflectstotal performance.

Total return measures both the income from an asset as well as changes in its market value. It helps credit unions answer: Is the loan or investment recorded at par on the balance sheet still worth that value if the transaction occurred today?

This tracking of total value is one of the outputs of most ALM models that project a credit union’s net economic value (NEV) into the future basedon changes in interest rate or other market-changing events.

The investment portfolio is an area of the balance sheet that potentially benefits the most from tracking total return performance. Credit unions can actively buy and sell assets, but even with a buy-and-hold investment strategy, total return fully revealsthe cumulative economic impact of individual security decisions over time at monthly, quarterly,and annual reporting intervals.

The Value Of Total Return For Investment Management

Tracking total return quickly nets out the individual security fluctuations into one easily tracked portfolio measure. Credit union investment managers make most individual investment decisions at one time, the time of purchase, and usually with the intentto hold the investment to maturity. The decision making is not often reevaluated. The original assumptions are not usually reviewed. If an investment manager must change a portfolio’s outcome, they primarily do so at the margin with the nextsecurity purchase. They rarely update prior decisions according to the new circumstances.

Tracking total return provides multiple insights for ongoing portfolio performance management decisions, including:

  • Total return’s economic value reporting allows a credit union to compare its investment performance with its overall budget and policy guidelines to decide whether it needs to rethink its parameters. Many credit unions today are tempted to stretch for yield to invest longer than normal when in fact they might have significant unrealized value in existing investments and future investments can stay within existing policy guidelines.
  • Credit unions can track portfolio performance against external benchmarks to monitor effective management. As in other areas of the credit union,balancing risk and return is the key decision factor. Sometimes a credit union’s investing is so conservative, for example stockpiling cash at the Federal Reserve, that it underperforms when compared to a Treasury bill duration benchmark. These lost earnings reduce potential member benefits.
  • Total return provides insight into asset allocation and pricing strategies across the entire balance sheet. For example, if the credit union is paying 35 basis points on its regular or money market shares,can it cover that cost with the investment portfolio?

Total return is not the only measure for investment portfolio management, but without this indicator, credit unions might not be making fully informed or performance-optimized investment and balance sheet decisions.

A Total Return Investment Tool

Any security, or portfolio, can calculate total return with the right analytics and market data. However, mutual funds are one class of securities that must, by regulation, reportthis information monthly for year-to-date, trailing 12 months, past three years and prior five years.

Credit unions are authorized to use mutual funds for investing when the portfolios are limited to securities authorized by the Federal Credit Union Act. These funds report a monthly distribution that is recorded as income but also calculates performancebased on any changes in the underlying portfolio’s market value the total return.

One example of this asset class is the Trust for Credit Unions’ family of mutual funds, which began 25 years ago by a group of leading credit unions. This $1.1 billion fund family recently reported the total return on its three portfolios for 2011. Both investors and non-investors can use this information to evaluate their owninvestment decisions and future options.

Mutual funds’ investment policies are established in the prospectus. These policies present the funds’ investment objectives, such as the duration target of the portfolio, the authorized investment securities, the fund’s performancebenchmarks, and expenses.

This reporting is a good model for credit unions to use in their own portfolio and risk management, as total return is the key mutual fund reporting and performance monitoring. This tool should be a part of every credit union’s 2012 investment performanceanalytics.

The Trust for Credit Unions (TCU) is a family of institutional mutual funds offered exclusively to credit unions. Callahan Financial Services is a wholly owned subsidiary of Callahan & Associates and is the distributor of the TCU mutual funds.Goldman Sachs Asset Management is the advisor of the TCU mutual funds. To obtain a prospectus that contains detailed fund information including investment policies, risk considerations, charges, and expenses, call Callahan Financial Services, Inc. at 800-CFS-5678.Please read the prospectus carefully before investing or sending money. Units of the Trust portfolios are not endorsed by, insured by, obligations of, or otherwise supported by the U.S. Government, the NCUSIF, the NCUA, or any other governmental agency.An investment in the portfolios involves risk including possible loss of principal.

This article is sponsored by a recognized solutions provider in the credit union industry. Callahan & Associates does not endorse vendors or the solutions they offer, and the views and opinions offered here might not reflect those of Callahan. If you are interested in contributing an article on CreditUnions.com, please contact the Callahan team at ads@creditunions.com or 1-800-446-7453.
May 23, 2014

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