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The Portfolio Manager’s Dilemma

July 24, 2009
Tony DePalo

The trough of the economic cycle is upon us, and the portfolio manager’s dilemma is becoming a reality once again. Loan demand has slowed at depository institutions, and again they find themselves flush with cash in another low rate environment. Through monetary policy, the government has fixed the fed funds rate at close to zero. That means this influx of cash earns almost nothing if left in cash. Most community banks understand the cost of sitting in such low yielding fed funds and are looking for investment opportunities. Yet, it is difficult to invest in fixed income assets with all of the inflationary talk. This low interest rate environment is again creating a great dilemma for the portfolio manager. Stay short and be ready for rates up but earn little while waiting, or invest longer to earn more at the potential cost of locking in the lows of interest rates. If we choose the latter, which security should we buy?

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