When Montgomery Asset Management of San Francisco unveiled its Short Duration Government Bond Fund, Deborah Hicks Midanek, director of mutual funds, was surprised by the interest among smaller banks.
The fund was for individual investors, and the firm didn't think it met Federal Financial Institutions Examination Council guidelines because it invested in corporates Ms. Midanek said.
But the bankers, searching for a way to increase short-term investment yields with safety and liquidity, saw a fit. And they also were intrigued by features that would help keep their banks in step with new financial accounting standards.
So, Ms. Midanek and her husband, James, who is chief investment officer of Montgomery Fixed Income Group, designed the Short Duration Government Portfolio for Financial Institutions.
Small banks often rely on just one officer for compliance or investment. But "the days when community bankers ran their investments out of their vest pockets are long gone," said Ed Furash, president of Furash & Co., in Washington.
Among the investment headaches for small banks is FAS 107, a financial accounting rule that will require banks to report in their financial statements estimates of fair value for their assets and liabilities and FAS 115, which will require them to estimate the effect of interest rate swings on earnings and equity.
The portfolio will provide daily valuations and detail the various securities, along with their interest rate sensitivity, in the fund.
The tide of government funds is being pushed not only by financial accounting regulations, but by the increasingly difficult problem of small institutions trying to hedge their rate risks, and the rapid development of derivatives, Mr. Furash said.
One of the derivative vehicles in which many small banks have invested is the Collateralized Mortgage Obligation, which "are ostensibly agency securities, but they are very complex instruments and frequently not what they appear to be," said John J. Lyons, a senior principal at Lyons, Zombak, Ostrowski, New York.
"Small banks are buying CMOs because their spreads are really in a box, but in many cases, they are dangerous. The banks need to be clear of regulatory criticism for investing in them, so they really need a professional manager to screen them."
Such CMOs as Montgomery might buy for the portfolio will be in a pool of cash and highly rated debt securities representing 35% of the fund's value; the remaining 65% will be represented by obligations either issued or guaranteed by the U.S. government.
Currently, the portfolio's yield is 120 basis points ahead of that for the two-year Treasury note, or 5.23%. The minimum investment is $1 million, and subsequent investments must be at least $50,000.
