What Is Portfolio Runoff?
Portfolio runoff method belongings with a finite period of time are not modified as they mature.
When the main invested in a fixed-income protection with a set maturity is repaid, the investor must come to a decision whether or not or to not reinvest it. When the proceeds from matured bonds are not reinvested, a portfolio can be discussed to be in runoff.
Key Takeaways
- Portfolio runoff describes a decline in fixed-term investment belongings.
- Portfolio runoff can occur when proceeds from maturing fixed-term securities are not reinvested.
- Investment returns decline through the years in a portfolio runoff since the asset base generating returns shrinks.
- Portfolio runoff can allow the Federal Reserve to cut back its balance sheet without selling holdings.
Balance Sheet Runoff
For a monetary establishment or lender, portfolio runoff can occur if it can not make new loans in brief enough to change the repaid ones it made in the past. Runoff can also occur when early prepayments are allowed or as defaults occur.
Banks can experience runoff when other people and corporations withdraw capital to invest in other higher-paying investments, thereby reducing the monetary establishment’s total capital.
So to reduce portfolio runoff, some loans specify prepayment penalties. The ones provide additional reimbursement for the lender if the borrower can repay a loan faster than the end of its period of time.
Runoff in Investment Portfolios
Fixed-income investments like asset-backed securities (ABS) and mortgage-backed securities (MBS), generally have a collection maturity date. For MBS, it might be based on the period of time of mortgages bundled to make up the protection.
If cash float from mortgage-backed securities is not reinvested, the earnings the portfolio generates will decline.
Federal Reserve Actions
The Federal Reserve bought Treasury debt and mortgage-backed securities in quantitative easing (QE) methods adopted following the 2008 financial crisis.
To start reducing its balance sheet the Fed does now not wish to advertise those securities; it would in fact merely choose not to reinvest some or all of the proceeds since the debt matures and is repaid.
Insurance policy Portfolio Runoff
Merely as a fixed-income investor may choose not to reinvest coupon expenses or main repayments, a reinsurer may choose not to write new insurance coverage insurance policies while taking a look ahead to those it in the past wrote to expire. Its portfolio would then be in runoff.
