Whilesome banks are preparing their investment portfolios for rising rates, some advisersare encouraging institutions to change their investment approach whether or nothigher rates come to pass.

A numberof banks have said they are keeping durationshort before interest rates rise, though the asset composition of theindustry's securities portfolios has not changed that much in recent years. Short-termrates have risen modestly since the Fed finally began raising rates in mid-December,but long-term rates have held fairly steady. The pace of future Fed rate hikes remainsup for debate, and rate predictions by economists and the futures market are currentlydiverging.

Economistsexpect the Federal Reserve to raise short-term rates twice before the close of 2016,according to a Wall Street Journal surveyof more than 60 economists, up from the current target rate of 25 to 50 basis points.The futures market, however, is only pricing in one rate hike before year-end 2016.

The differingviewpoints have only added to volatility to markets. Some observers argue that certainregulations facing big banks such as the Volcker rule and the liquidity coverageratio have reduced liquidity in the markets and contributed to the volatility aswell.

PIMCOSenior Vice President and Portfolio Manager Chitrang Purani said during a recentwebinar hosted by SNL Financial that he has seen higher volatilityin the markets. He said increased bank regulation has reduced the ability to warehouserisk and made it more expensive for banks to trade securities. Against that backdrop,he said it is more important for banks to be more "active and nimble"with their investment approach.

Bankscan pick their spots and take advantage to opportunistically enter certain spreadsectors when volatility occurs, he said. Being nimble is especially important whensecurities are close to 20% of most banks' balance sheets, Purani said.

The balancesheet concentration of banks' investment portfolios has declined modestly in recentquarters, but still remains quite large. SNL data shows that securities equatedto a median of 19.1% of assets at the end of the fourth quarter, compared with 20.3%a year earlier and 21.2% two years ago. Loans, meanwhile, have grown to a medianof 66.0% of assets from 64.6% a year earlier and 62.7% two years ago.

Whilesecurities have declined as portions of most banks' balance sheets, further declinesat some institutions could be limited due to regulations. For instance, banks withmore than $50 billion in assets, which held 72.3% of all securities in the bankingindustry at year-end 2015, are required to maintain certain security balances tocomply with the liquidity coverageratio, or LCR. Institutions subject to the LCR are required to holdhigh-quality liquid assets that can be quickly converted into cash nearly equalingor exceeding projected net cash outflows during 30 days of financial stress. Manyof those high-quality liquid assets, or HQLAs, are low-yielding securities suchas Treasurys and agency debt, though there is a legislative push to include municipal bonds in the classification.

Smallerinstitutions, meanwhile, have more freedom to diversify their portfolios. Most smallbanks still follow the general industry trend of holding a significant amount RMBS,government securities and municipal bonds, Purani said during the webinar. However,he argued that small banks having a hard time growing their loan portfolios candiversify risk in their securities portfolio, while helping alleviate some net interestmargin pressure.

PIMCOVice President Thomas Luciano added that securities should complement what a bankhas in its loan portfolio. Most community banks have localized lending exposurewhereas they can diversify their geographic exposure through their securities portfolio,he said.

Manybanks have not changed their securities portfolio composition that much, even asthe prospect of the rate cycle changing looms over the market. During the webinarwith the PIMCO professionals, SNL asked the audience, which primarily consistedof executives and professionals from community banks, if they had changed theirinvesting approach in the last 12 months. Just 40% of the roughly 200 respondentssaid they had made changes.

The majorityof respondents said they had not changed their investment approach, even thoughnearly 80% of listeners on the webinar said they believed banks should considerrevisiting their investment portfolio strategy ahead of rising rates.

In recentquarters, asset composition across the banking industry's securities holdings hasnot changed that much, but institutions have modestly decreased their concentrationsin rate-sensitive securities. Banks have continued to decrease RMBS balances intheir securities portfolios. RMBS could experience more significant price movementsin a rising-rate environment due to negative convexity from extension risk, or therisk that investors will hold below-market rate securities for longer periods oftime since prepayment speeds will slow when rates rise. The industry trimmed itsrelative exposure to RMBS in the fourth quarter, decreasing those balances to amedian 28.3% of total securities, compared to 31.1% a year earlier, according toSNL data.

Banks'holdings of government securities have decreased as well, declining to a medianof 21.2% of securities in the fourth quarter of 2015 from 22.3% a year earlier.

Banks'muni exposure, however, continued to grow in the fourth quarter, rising to 27.0%of total securities, on a median basis, from 24.6% a year earlier.

Bankscan and should consider changing their exposures some whether rates move higheror not, according to Purani. He said banks' securities portfolios represent the"easiest lever" they can pull to help achieve their asset/liability management,capital and net interest margin goals. He said banks need to understand the risksin their loan portfolio and balance those risks against the opportunities they seein the market.

"It'sreally more complementary than mutually exclusive," Purani said of investing.