Investment Services


Dietmar Huesch
Vice President, Treasury & Funding

Time to look at those investment ladders again!

The fed funds rate stands at two percent and the outlook for both short-term and long-term rates remains uncertain. Current levels are certainly low on a historical basis and could rise significantly once a return to more normal and robust economic growth becomes predictable. At the moment, however, the woes in the housing market and surging food and energy prices threaten that outlook. An extended period with the yield curve remaining floater inverted may have led you to move away from the laddering concept to boost short-term yields. Now would be a good time to re-visit the merits of maintaining a stable laddered investment structure.

All types of depository institutions, including a large number of credit unions, utilize the laddered maturity concept for several basic reasons:

  • It is a good way of maintaining a passive investment strategy and avoiding having to spend a lot of time on “timing,” “sector” and “maturity” decisions.
  • Having predictable maturities on a regular basis facilitates liquidity management, minimizes the amount of overnight cash that needs to be retained, and provides ready funds for new loan opportunities. (I do need to note that if you keep your entire term portfolio in a ladder, you will need to rebalance the “rungs” when you reduce the aggregate size of the ladder.)
  • For investment managers that have the time and expertise to take on a more active management style, having a ladder form the core of the portfolio frees them up to be more aggressive and opportunistic in the rest of the portfolio.
  • Investment ladders have tended to perform very well over an extended time horizon.

WesCorp has written numerous articles and made a number of presentations on this subject. Different articles have covered the impact of providing a steady flow of liquidity back to the credit union, protecting your NII in an unexpected drop in interest rates, and about ladders being the fixed-income version of dollar-cost averaging.

Laddering has been extremely successful in terms of providing a consistent investment return over time. Annual income on $10 million invested in a one-year ladder produced an average spread return of $63,334 more than the return from leaving the funds invested in an overnight account, while a five-year ladder produced an average of $204,760. Imagine gaining all this income while not having to figure out when or in which direction rates were moving. That’s the main benefit of maintaining a stable investment ladder—you have a passive investment strategy that does not require any market timing.

You might have a concern about using a ladder as long as three or five years, but remember, this is a portfolio that has funds maturing every month. The actual average lives of these ladders are just slightly above one-half of the longest maturity, 18.5 months for the three-year ladder, and 30.5 months for the five-year ladder.

The best performing structures are normally longer maturity investments, which typically carry a higher liquidity premium than shorter maturity investments. Also, since the yield curve is normally upward sloping, the five-year yield is typically higher than the shorter maturities. Finally, the 60-month term of the five-year ladder spans multiple rate environments and is not as susceptible to the short-term trends as the shorter ladders are.

What length of ladder is right for you? It depends on how comfortable you are with the overall interest rate sensitivity of your balance sheet. As for ladders, history suggests that the longer the better.

Why have the headaches of trying to guess when to time your investments, or where interest rates are going next, when you have a simple, successful, mechanical, headache-free investment strategy? Investment ladders work and can provide your credit union with a boost in earnings.

As Vice President, Treasury & Funding, Dee Huesch is responsible for the pricing and development of WesCorp’s share accounts, structured investments, credit products, and loan products. You can reach him at dhuesch@wescorp.org. You can see his complete article in WesCorp’s InsideRISK magazine (Vol 8, No 2, 2008).