Seeking better returns in a low-yield environment, central banks are undertaking a “gradual but definite expansion” of investment and trading activity beyond their conventional boundaries, says a new report published by BNY Mellon in collaboration with Cambridge Judge Business School, University of Cambridge.
The report found that while most central bank portfolios remain weighted toward major currency government bonds and money market instruments, some central banks are investing in a wider range of asset classes, currencies and instruments as they look “well beyond the central banks’ traditional focus on G-10 currency-denominated government debt.”
“Looking to the future, a third of respondents indicated they had recently or were planning to invest in new markets of asset classes,” said the report – entitled Central Banks 2018: Trends & Investment Outlook – which stemmed from interview-based surveys of central banks across three continents. “In most cases, the motivation is to increase yield, with a wide range of instruments targeted, including equities, corporate bonds, and real estate.”
The survey, conducted as part of a Group Consulting Project by four Master of Finance (MFin) students at Cambridge Judge, also found that 39 per cent of central bank respondents already invest in equities; one third currently undertake securities lending; and 61 per cent confirmed active participation in short-term repurchase agreement (“repo” markets) for government securities, with 39 per cent investing in time deposits.
While central banks’ responsibilities make them “relatively cautious” in exploring new investment opportunities, there is “both anecdotal and statistical evidence of growing sophistication and innovation by institutions willing and able to invest beyond established parameters.”
And while the survey found “little appetite” for larger investment in emerging market assets, some central banks are exploring investments denominated in Chinese Renminbi (RMB).
As central banks diversify their investments, the report forecasts that investment guidelines will evolve. “Although many central banks will continue to operate within relatively narrow investment guidelines, there are an increasing number of bespoke approaches – including hedging strategies to offset interest rates and commodity price shifts – that can be adopted without breaching mandates,” the report says.
About half of central bank respondents said they are planning a technology upgrade, with some switching from in-house to third-party core systems and others building more robust defences against cyber-crime.
“Systems and workflows designed or acquired to manage and report on a relatively narrow spread of liquid, standardised fixed-income instruments will be challenged to do the same for less-liquid, bespoke and over-the-counter investments,” the report says.
The Group Consulting Project that contributed to the BNY Mellon report was conducted in March-April 2017 by Cambridge Judge MFin students Ashish Srivastava, Meshaal Al-Saleh, Miho Kawai, and Pattarin Uthayopas, all members of the class of 2016-2017. The report draws on data from the student survey interviews and expertise of BNY staff serving the central banking sector.
Dr Simon Taylor, Director of the MFin programme for experienced finance professionals at Cambridge Judge, said the project for BNY Mellon was particularly timely.
“Investment professionals around the world have been faced with a low-yield environment for a decade now, as interest rates have remained low and economic recovery in developed countries has been slow and uneven,” he said. “The BNY Mellon report shows that central banks, like other institutions, are seeking ways to increase yield, and are looking at new approaches that go beyond the traditional remit we usually associate with central bankers.”