Central banks look to third-party fund managers as asset diversification gathers pace
Global central banks are developing a stronger appetite for external fund managers to oversee a wide range of asset classes held on their ballooning balance sheets, a new study has found.
According to the 2021 Global Public Investor (GPI) survey produced by the Official Monetary and Financial Institutions Forum (OMFIF), central banks “are becoming far more adventurous as investors, increasing their exposure to equities and experimenting with a broader array of asset classes, including relatively illiquid infrastructure bonds”.
“As with sovereign and pension funds – their global public investor peers – this development requires forging close relationships with external managers,” the OMFIF report says.
While just 6 per cent of global central bank assets are managed by external firms compared to almost 40 per cent sovereign wealth and pension funds, the study says monetary authorities are increasingly looking to diversify reserves beyond traditional safe havens.
“…by engaging some of the world’s biggest fund management firms, those reserve managers gain access to new and more complex asset classes with the potential to outperform in a lower-for-longer environment,” the study says.
In fact, the OMFIF report says central banks have been ramping up exposure to risk assets since the widespread introduction of quantitative easing policies in 2008 when reserve investment tastes were overwhelmingly vanilla.
“For example, around the time of the 2008 financial crisis, few central banks invested in corporate credit, and even fewer held equities,” the study says. “But in 2021, a generic reserves portfolio looks very different.”
Entering the COVID slump last year central banks also held a higher level of foreign exchange reserves “than in the run-up to all previous financial crises”, the report says, but seemed reluctant to deploy offshore cash to battle currency shocks.
“The growing prominence of equities in central bank reserves portfolios is a neat corollary to the notion that many central banks are unwilling to use all their foreign exchange reserves during a shock,” the OMFIF study says. “While the types of equities central banks generally invest in are highly liquid, they represent a more return-orientated, productive investment than fixed income products. Indeed, 27% of central banks surveyed said that they planned to add to their equity exposure over the coming two years, showing that diversification will continue.”
Last week the Reserve Bank of NZ (RBNZ) published an overview of its ‘additional monetary policy toolkit’, listing foreign asset purchases as one of six extra strategies (beyond interest rate tinkering) to manage financial conditions in NZ.
“International evidence shows purchases of foreign assets can be an effective way of putting downward pressure on the exchange rate and easing broader monetary conditions, if the programme is large enough and credible,” the RBNZ paper says – although the strategy “could result in losses if the exchange rate subsequently appreciated”.
The 140-page OMFIF report covers a lot of ground for the GPI community including an overview on ‘shareholder influence’ by NZ Superannuation Fund (NZS) chief investment officer, Stephen Gilmore.
As well the report ranks NZS as 199 in its list of the 850 largest GPIs with both the RBNZ (293) and Annuitas (526) making the cut.
OMFIF chair, David Marsh, says in the report that the survey – first published in the 2014 – tracks “risk management by sovereign institutions around the world”.
“… central banks have entered a domain where they can be accused of promoting fiscal dominance. Their actions can be regarded as principally geared to help governments manage their much-increased debt rather than safeguard monetary stability. GPIs and the governments and citizens behind them are thus caught in a matrix of intertwining risks,” Marsh says.
“The most obvious one, but by no means the most frightening, is that a persistent rise in inflation would force the Fed to start tightening credit much earlier than originally expected. This would cause acute dilemmas for monetary authorities around the world faced with a choice of allowing their currencies to depreciate or to raise interest rates with calamitous consequences for their governments’ debt management policies. That moment of reckoning is likely to come, sooner or later. It will preoccupy GPIs in the months ahead.”