Are you sure?

Yield, derivatives attract central bank reserve managers - survey

Central bank reserve managers are still searching for yield after the credit turmoil and more than half view derivatives as an attractive asset class to invest foreign exchange reserves, a survey showed on Monday.

A survey of 51 official reserve managers controlling reserves worth $2.39 trillion -- just under 38% of the world’s total -- also found central banks preferring AA-rated government bonds. The survey only asked for their preferences outside tripe-A holdings. The preference shows how the ongoing credit crunch has put renewed emphasis on preserving safety and liquidity, even within the category of higher-yielding central bank investments. More than 90% of the respondents surveyed by specialist magazine Central Banking Publications said the global financial turmoil had an impact on their reserve management policy, with one in five saying a major one. “The recent crisis has of course been a reminder of the risk associated with non-government bonds etc: the yield pick-up is not a free lunch. However, we still believe that there are long-term risk premia and diversification benefits to be had from investing in non-government bonds,” one European central bank reserve manager said.

Nearly 60% of the respondents said derivatives were a more attractive class now than 12 months ago, while around 40% said corporate bonds with ratings above triple-B, agency paper and commodities were more attractive. Almost one in five of those polled said they saw Mortgage-Backed Securities (MBS) as more attractive than this time last year even given the housing and mortgage-related chaos of the past six months. “For agencies and MBS, the spreads are attractive, which is an incentive to invest in them. Derivatives are an effective vehicle to modify portfolio positioning especially in volatile environments,” two reserve managers from Americas said. “The re-pricing of risk that has occurred during the last few months has created attractive investment opportunities among lower-rated securities and alternative asset classes. In contrast, flight to quality has caused a significant decrease in rates on highly rated government paper to multi-year lows.”

However, more than 90% said corporate bonds below triple B ratings and Asset Backed Securities are less attractive, while 81% saw MBS as less attractive. Eighty-three percent of them said AA-rated government bonds were more attractive compared with a year ago.

Euro, yen favored
More than 60% of the managers reported an increase in the proportion of euros in their reserves in the previous 12 months. Half reduced the proportion of dollars, while 23% added yen. Twenty central banks reported no change or no significant change in their currency mix. Of those who had increased euros, two mentioned the changing structure of their national debt and another two identified currency diversification as factors influencing their policies. “Dollar weakness is the overriding consideration in the short-term. That is likely to reverse going forward,” a reserve manager from an African central bank said. Twenty nine managers use external managers to run a portion of reserves and the number has been steady since 2002. Most central banks outsource a relatively small portion of their reserves. Almost four out of five respondents said external managers were responsible for less than 10% of reserves.

Central banks face a wide variety of challenges in their relationships with external managers. The most common aspect was to do with performance. “The past performance of managers that we observe when they work for us tends to be a good predictor of how they will perform in the future,” a Middle Eastern central banker said. “However, we have not yet found a satisfactory way of getting this information before signing a new manager.” Another manager from Americas said: “In terms of excess return, the results have been slightly disappointing since professional asset managers subject to the same constraints as the internal management team have not achieved, on average, any significant out-performance relative to the central bank’s staff or the benchmark.”

Many respondents felt growth of sovereign wealth funds (SWFs) and increasing publicity would have an impact in the areas of increased pressure for disclosure and change in investment strategy. “The growth of SWFs could have implications for investment strategy, disclosure, risk management, etc. of central banks’ reserves. However, we need to take differences in purpose and institutional setting into consideration when we compare central banks’ reserves with SWFs,” an Asian reserve manager said.

The survey was sponsored by Royal Bank of Scotland (Reuters)