Published in: Credit Union Business
Many institutions take credit risk in their loan portfolio and avoid this exposure in the bond portfolio. However, adding credit exposure to an investment portfolio gives investors an opportunity to enhance expected returns as well as diversify risk at the portfolio level. As is the case when underwriting loans, portfolio managers need to properly evaluate potential investments before they are added to the portfolio, and once they have been added, these securities need to be monitored as part of a regular portfolio management process.
Historically, credit-risky assets have some diversification benefit when combined with agency MBS. Exhibit 1 shows the two-year correlations of monthly returns, and as the table illustrates, agency MBS have lower correlations with credit-risky assets than they do with Treasuries and agency bullets.