Pub. 9 2020 Issue 1

January/February 2020 19 l e a d i n g a d v o c a t e f o r t h e b a n k i n g i n d u s t r y i n k a n s a s but so is self-awareness; managing risk for multiple outcomes requires at least a tacit admission that one’s view of the future might be wrong. Such an epiphany can suggest behavior that may seem to go against the grain. The Boy Who Cried “Bear!” In 2009, the winter edition of the FDIC publication Supervisory Insights contained a piece entitled “Nowhere to Go but Up: Managing Interest Rate Risk in a Low-Rate Environment.” It was filled with cautionary encouragement for banks to make preparations for higher market rates; not at all unreasonable given that short-term rates were barely hovering above zero. But also back then, Ten-Year Treasuries were yielding close to 4% and the nominal yield of the Bond Buyer 20 Year G.O. Muni Index was around 4.25%. Needless to say, those risk managers who were only managing for a single outcome, the one defined by higher rates, avoided such things. The “smart” money stayed short because that’s what smart money does when it “knows” rates have nowhere to go but up. As a result, many “smart” portfolio managers missed some big investment opportunities because their strategy was too invested in a perception that allowed no room for any world that didn’t involve higher and rising interest rates. A world that is still worlds away. What If You Didn’t Have to be Right? What about risk managers who operate without an overriding market bias? How do managers manage without an emotional investment in a rate forecast? They do it by allowing for the possibility of multiple outcomes, even some unlikely ones. Those portfolio managers who invested in twenty-year municipal bonds back in 2009 didn’t do it because they “knew” rates were going to fall, which they did; they did it because they didn’t know what rates were going to do. They loaded up on high cash-flow instruments at the same time and for the same reason: they didn’t know where rates were headed but they wanted to be ready for anything. And they have been. Their long-term, high-yielding bonds have provided much needed income during times when yields trended downward, and their reservoir of short-term cash flow has been a repricing boon for those times when rates trended higher or back-up liquidity was needed. Successful risk managers don’t have to be smart enough to see into the future, they just have to be smart enough to realize they can’t. Lester Murray joined The Baker Group in 1986 and is an Associate Partner within the firm’s Financial Strategies Group. He helps community financial institutions develop and implement investment and interest rate risk management strategies. Before joining The Baker Group, he worked at two broker/dealer banks in Oklahoma City and was also an assistant national bank examiner. A graduate of Oklahoma State University, he holds Bachelor of Science degrees in finance and economics. Contact: 800-937-2257 , lester@GoBaker.com .