A Better Approach to Investment Management

Rethinking the Questions We Ask
As the manager of a credit union investment portfolio, are you still asking questions that are impossible to answer? Questions like:

• Where will interest rates go from here?
• Is there a recession on the horizon?
• Will mortgage securities outperform treasuries this year?

Strategists and financial media have built empires asking these and other similar questions, while providing answers that have limited value. Study after study shows even the most experienced experts struggle to consistently predict the future. There are simply too many unknown variables that affect financial markets.

Successful strategies for investing are not about making accurate predictions. Instead, they focus on making sound decisions under the cloud of uncertainty. The most effective investors think in terms of probabilities rather than predictions. Rather than relying on a single forecast that may prove right or wrong, they consider a range of possible outcomes and the likelihood of each. This mindset shapes how portfolios are built, managed, and evaluated.

The Problem with Predicting
As humans, we are drawn to certainty. We prefer answers that are clear when actual outcomes are loaded with ambiguity. Statements like “the Fed will be forced to increase rates at the next FOMC meeting” are predictive. They imply a level of confidence in one specific outcome.

The problem with this approach is that markets rarely reward predictive thinking. While there are occasional examples of investors earning outsized rewards by correctly forecasting the future, these successes are vastly outnumbered by inaccurate predictions. Most incorrect forecasts are not remembered unless they result in significant financial damage. History is full of examples where consensus forecasts were not only incorrect about the magnitude of market changes, but also in their direction. For example, market pundits were positive on continued outperformance in mortgage securities leading up to the financial crisis of 2008.

Predictive investors tend to allocate investment decisions to perform in a particular outcome. If one expects interest rates to drop, they may load up on longer maturity securities to take advantage of the predicted price increase, should that forecast prove true. However, if the prediction is inaccurate, the losses can be severe. In this case, the losses are not caused by an inaccurate forecast, but by the decision to rely on that forecast. The portfolio was repositioned as though there was only one possible outcome.

To think in probabilities, you must first accept that every forecast carries uncertainty, no matter how confidently it is delivered. Changing the question from “what will happen” to “what can happen” is how we can change to a better mindset.

Start with a Purpose
Credit union investing begins from a different starting point than a predictive strategy. Instead, the focus is on identifying the obligations the portfolio is intended to support. For a credit union, those obligations are its liabilities, primarily member deposits. The portfolio must maintain appropriate liquidity to support the liabilities under many interest rate scenarios. Our goal is not to earn the highest return; rather, it is to earn a sufficient return while ensuring future liabilities can be met. The distinction may be subtle, but recognizing the difference changes every aspect of investment portfolio management.

Define Risk Correctly
One of the benefits of using a liability-based approach is that it helps define risk in a more concrete way. Traditional investment analysis defines risk as price volatility. Liability-based investing offers a different view. Risk is now seen as the possibility that assets will not be sufficient to meet future obligations.

This distinction can reveal risk in assets that may appear safe at first glance. Cash, for example, is often viewed as the safest option because it carries little market volatility. However, if cash returns are too low to keep pace with the cost of liabilities, the portfolio may underperform and become less able to meet future obligations. In that context, accepting some market volatility may be necessary to generate enough income to support the credit union’s liabilities.

Using this mindset, successful investing is measured not by outperformance but by maintaining or improving the characteristics of the funding portion of the balance sheet, liability portion.

Asset-Liability Matching
For a credit union, the biggest application of liability thinking is asset-liability matching. This thinking aligns the characteristics of the investments with the characteristics of the funding source, liabilities. If liabilities extend ten years into the future (a rarity for a credit union), assets should have a duration sufficient to respond similarly to changes in interest rates. If obligations require predictable cash flows, investments should also provide predictable cash flows.

The objective is not return maximization but to reduce risk that assets and liabilities move in opposite directions. This concept is especially relevant to fixed income investing. Bonds are often measured only by projected returns (yield). However, from a liability management perspective, the more important measure should be whether a bond’s cash flow structure helps support the obligations of a credit union.

What This Means for Credit Unions
Liability based investing has relevance for credit unions. We rely more heavily on member deposits as a source of funding than many other investors. Those liabilities can react differently in various interest rate environments, competitive, and economic conditions.

Traditional investment philosophy emphasized return maximization. While return is an important metric, focusing only on yield can create unintended risks.

Liability focused credit unions can begin by asking:

• How do deposits react to interest rate changes?
• What liquidity demands do we have in stressed scenarios?
• How sensitive are earnings and capital to interest rate changes?
• What cash flow obligations do we have to fund over the coming months and years?

Answering these questions may lead to a significantly different portfolio from one designed to maximize yield. The goal is no longer to predict perfectly, but to remain resilient regardless of how interest rates move.

Scenario Test Rather Than Forecast
Liability-based investing requires scenario testing rather than forecasting. Forecasting attempts to predict the future. Scenario testing examines what happens under multiple futures.

Some scenarios to consider:

• Rapid increase/decrease in interest rates
• Sharp run-off in deposits
• Economic recession
• Liquidity shortfall

Instead of predicting which scenario might occur, managers can evaluate if the credit union can meet obligations in any of these scenarios. This approach recognizes that unexpected events occur more frequently than experts and their models can predict. Preparing for a range of outcomes can lead to better performance during periods of uncertainty than relying on a single forecast and assuming it will be correct.

So What?
Despite our need for certainty, the future remains uncertain. Headlines will continue to surprise investors, and no method of forecasting can eliminate uncertainty. Fortunately, successful management of an investment portfolio does not require perfect predictions. A liability-based approach allows credit unions to focus on meeting their obligations while remaining resilient across a range of potential outcomes.

A stronger investment strategy does not depend on predicting every market movement. It begins with understanding your credit union’s obligations and preparing for a range of possible outcomes. Corporate Central’s investment and liquidity solutions can help your credit union build a thoughtful approach that balances liquidity, risk, and return.

About the Author

Kevin P. Chiappetta, CFA, is SVP and Chief Education Officer at Corporate Central Credit Union, where he helps credit unions navigate investment strategy, balance sheet management, and interest rate risk. With extensive experience in fixed income markets and asset liability management, he works with credit unions and industry leaders to develop resilient, risk-aware investment programs.

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