OMFIF’s Global Public Investor reports have been tracking the investment and asset allocation decisions of central banks around the world for over a decade. Our survey of central bank reserve managers, now in its sixth year, explores the macro factors influencing investment, asset and currency allocation decisions and sustainable investment and practices of central bank reserve managers.
This year’s report – which surveyed 73 central banks with international reserve assets totalling $5.4tn – was a litmus test of whether we have returned to normal following several years of global crises, or whether we have entered a new normal. We posed the question: stick or twist? In doing so, we sought to explore whether reserve managers would stick with traditional fixed income assets or twist and diversify into new asset classes.
We found that reserve managers believe we are facing a more volatile and fragmented macroenvironment, and this is influencing their asset and currency allocation decisions.
Reevaluating renminbi exposure
Motivated by the need to diversify currency holdings and improve risk-adjusted returns, central banks have been investing in renminbi for the past several years. According to the GPI survey, 30% of respondents indicated an intention to increase renminbi holdings over a two-year period in 2021 and 2022, which fell to 10% in 2023 but remained higher than for any other currency. But for 2024, a mix of cyclical and structural factors have stalled the Chinese currency’s growth as a reserve currency.
Prior to the interest rate hiking cycles in the US and Europe, the renminbi was seen as a good diversification option due to the yield spread between renminbi-denominated government bonds and USD- and EUR-denominated bonds. Yet, comparatively low growth and a lacklustre outlook for the Chinese economy alongside higher interest rates in developed economies have made the renminbi less attractive.
In addition, geopolitics was listed by around 70% of survey respondents as a discouraging factor for investing in Chinese financial assets. At a recent OMFIF discussion, one reserve manager stated that, ‘In 2022, we were one of the first central banks to sell 75-80% of our renminbi holdings, because of the perceived geopolitical tensions and China not being clear on their Ukraine position. Now many [central banks] are doing the same.’ Another reserve manager noted that their institution had gone even further to reduce renminbi exposure: ‘We saw gains [from renminbi holdings], but geopolitical risk factors were part of the decision to reduce holdings to 0%.’
Higher-for-longer rates making fixed income more attractive
Central banks expect structurally higher rates compared to pre-pandemic levels, with 78% of survey respondents anticipating the trend. At the GPI 2024 launch, Ricardo Martinelli, senior adviser on foreign reserves at Banco Central do Brasil, noted that ‘longer-term inflation will be higher than the past 10 years due to demographics, defense spending, the energy transition and deglobalisation.’ These factors are influencing central banks’ investment strategies and asset allocation decisions. ‘We are in a higher interest rate environment… which means for some central banks, having more liquidity can be more important.’
As highly liquid assets which are now non-zero yielding, it follows that fixed income is back for reserve managers looking to balance yield and liquidity. ‘In the area of fixed income assets, there are plenty of opportunities now,’ explained Antonela Peci, head of investment strategy and credit risk at the Bank of Albania. ‘Diversification in the current environment – with volatility and geopolitical risk – doesn’t give the result that has been evaluated in normal conditions. Central banks will be prudent in diversifying.’
Preparing for future diversification
Looking ahead to diversification strategies beyond fixed income, risk appetite remained low among respondents in this year’s GPI survey. Just 9% of respondents intend to increase equity holdings over the next two years, 3% for asset-backed securities and 5% for real estate. But discussions with reserve managers suggest that over a longer time horizon, diversifying into non-traditional asset classes and even alternatives may be the way forward.
‘If you are moving into a space where inflation is becoming more and more important [as an investment consideration], alternative markets like infrastructure and real estate offer a good hedge,’ reflected Martinelli, who anticipates that central banks will continue to move toward alternatives over the coming years.
There are still some limitations to how central banks can invest in nontraditional asset classes, given their mandate for market neutrality. ‘We do not invest in single names, we’re not comfortable buying specific companies; for equities and also for corporate bonds, we use ETFs to have exposure,’ explained Martinelli. Passive funds like exchange-traded funds may be becoming more mainstream investment vehicles for central banks, a trend also evident in the GPI 2024 survey.
Discernment increasingly important in emerging markets
As central banks seek diversification opportunities, some are looking to invest in emerging markets. Due to high interest rates on government bonds in advanced markets and foreign exchange risk heightened by a strong dollar, the risk premium on EM debt is less attractive than in previous years. But US interest rates will come down over the medium term, offering higher yields in EMs poised for higher growth.
As a result of deglobalisation or the ‘regionalisation’ of trade dynamics, there is increasing importance in analysing country-specific fundamentals and identifying investment opportunities in emerging markets. There will be investment opportunities, especially ‘if you understand which countries are benefitting from this new redistribution of factories and commodities,’ explained Zongyuan Zoe Liu, Maurice R. Greenberg Fellow for China Studies at the Council on Foreign Relations at the GPI launch.
Investing in green bonds, albeit passively
Central banks are also slowly working to green their portfolios. GPI data demonstrate that the share of survey respondents investing in sustainable assets – such as green and other labelled bonds –has increased from under 50% in 2021 to 67% this year. But it appears that most reserve managers are passively investing in labelled bonds, as they have become a natural part of the traditional sovereign, supranational and agency bond market and because they meet other investment criteria.
This passive strategy was echoed by Peci, who stated at the launch that, ‘We currently buy sustainable bonds, but we don’t have a green mandate’. Integrating sustainability as a fourth objective in the Bank of Albania’s mandate is an ongoing process. Other central banks will likely follow suit.
Taylor Pearce is Lead Economist, Economic and Monetary Policy Institute at OMFIF.
The entire Global Public Investor 2024 report is available below for download. The report launch and panel discussion can be viewed here.
