If you're like most of us who manage money in a mid-sized bank, you wear many hats and find you can't focus your attention on the markets as much as you would like. How, then, in this world of ever more complex financial instruments can you be certain that you're purchasing the best investments at the best prices?

[Expanded Picture]I have a strategy that has worked well for me in the past. It involves three steps:

Make a Plan

You will be less likely to buy the wrong investment if you have a plan outlining what you are willing to buy. You can build that plan by dedicating a percentage of your portfolio to the management of each of the following: liquidity, interest rate risk and earnings generation.

The liquidity portion of your investment portfolio should be easily marketable, or have maturities of a year or less. The interest rate risk portion should have repricing or maturity characteristics similar to that of your funding structure. The portion designated for earnings generation should have the potential for capital gains. The percentages dedicated to each will depend upon your bank's asset/liability profile. if a prospective investment doesn't fit into your asset/liability plan, don't purchase it regardless of how attractive it is.

Always dedicate a small portion of your plan (under 10%, depending on your risk tolerance) for trading. No matter how conservative you are, you will want to trade. if you concede that and set some guidelines, you will keep yourself from betting the bank when that broker calls with an "excellent buying opportunity."

Also know at what price most investments trade. Most brokerages publish a daily market update which shows at what approximate spread to the treasury curve bonds should trade. They will fax you this update if you ask.

Work With People You Trust

The right broker can make you a lot of money. The wrong one can cost you your job. Get referrals from other bank portfolio managers. You should only work with people who work with other banks. Banks have distinctive regulations governing what types of investments they can purchase and a broker who specializes in banks will not waste your time showing you investments that you cannot purchase. They also may be able to provide ideas about how other banks are making money.

I always ask if the individual has at least five years of experience in this business. (I am tired of explaining repurchase agreements to 22-year-olds.) The securities industry is full of transients who think A/L management is a great way to make easy money.

Avoid brokers who call infrequently, or only call when they have something to sell. Serious institutional brokers will work with you for up to a year providing product and market education before they expect a sale.

When In Doubt Don't Buy It

Don't be afraid to ask fundamental questions. Always probe to determine an investment's worst case yield or return. Could you have with that outcome? If you can't, the investment doesn't belong in your portfolio.

When used properly, structured notes and derivatives are excellent ways to reduce the risk in your balance sheet. But you have to be able to evaluate them. Among the best money our bank ever spent was to lease a Bloomberg terminal. For an annual charge of $20,000 we are able to see all the features of each investment we consider, and how that investment behaves under different rate environments. We've added 14 basis points to our portfolio yield with little additional risk.

More importantly we've avoided some costly mistakes. Recently a primary dealer tried to sell us a "kitchen sink" bond. These instruments are collateralized by everything including the proverbial kitchen sink (See Assets & Liabilities, March 1994). Even sophisticated portfolio models have trouble assessing their behavior under different interest rate environments, and they were simply inappropriate for a mid-sized bank's portfolio. Without the Bloomberg, we couldn't have made that determination.

There are plenty of hazards out there for A/L managers, but this straightforward three-step approach should enable you to plan with greater confidence.

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