Central banks torn between return and liquidity objectives

This month, AsianInvestor is running a series of stories on the decisions driving the fixed income choices of institutional investors as 10-year US treasuries drop further below zero.
Central banks torn between return and liquidity objectives

Central banks are weighing up lower-rated sovereign debt but staying within relatively safe territory as they seek to balance returns with capital preservation and liquidity objectives in a low-yield environment.

Nearly 30% of central banks surveyed expect to increase their allocation to non-AAA investment-grade sovereign and supranational debt within the next 12-24 months, according to a report published in July by UK think-tank Official Monetary and Financial Institutions Forum (Omfif).

In contrast, a smaller proportion of investors said they would increase allocation to traditionally safe foreign currency debt, with only 12% planning to increase Euro-denominated sovereign debt holdings and less than 4% Japanese yen-denominated debt.

Additionally, 24% of central banks surveyed were looking to increase their exposure to emerging market sovereign bonds, while 28% planned to decrease allocation to developed market sovereigns.

"In the next 12-24 months do you expect to increase, reduce, or maintain your allocation to government bonds in the categories below?" % of total responses from central banks
Source: Omfif Global Public Investor Survey 2021


The findings reflect the challenge that reserve managers today face in trying to balance their returns, safety and liquidity objectives, particularly as governments loosen monetary policy in reaction to the Covid-19 pandemic.

Loose monetary policies around the world and low interest rates have affected yields of fixed income traditionally favoured by reserve managers. The real yield on 10-year US Treasuries, a traditional reserve asset for central banks, hit record lows of minus 1.127% last week.

Meanwhile, yields of emerging market sovereign and BBB-B sovereign external debt remain consistently above those of Euro sovereign and AAA-AA Euro government bonds.

Index returns on different government bonds
Source: Thomson Reuters, Omfif analysis

As a result, central banks have had to seek ways to maintain returns, while ensuring their other objectives are met. 

“Given the liquidity and capital preservation objectives of the portfolio, we do not have a choice but to maintain the liquidity profile of the portfolio at the cost of lower return,” one central bank respondent said.

In response to how it is diversifying its bond portfolio in light of the low-rate environment, a spokesperson for the Monetary Authority of Singapore (MAS) said, "MAS's reserves are invested in a well-diversified portfolio of cash, bonds and equities across advanced and emerging market economies. About three-quarters of the official foreign reserves are denominated in the US dollar, euro, Japanese yen and British pound, with the US dollar forming the bulk within the G4 currencies."

Natalia Ospina, head of policy analysis at Omfif, said that central bank’s efforts to simultaneously meet capital preservation, liquidity and return goals have become more complicated and that the distinction between the three has become less clear cut.

“These lines between the objectives of central banks are being blurred because central bank monetary policy independence is being blurred, because of what governments are doing in response to the pandemic,” she told AsianInvestor

Natalia Ospina, Omfif

“The world is a lot more complicated right now,” agreed Ramon Maronilla, fixed income investment specialist at JP Morgan Asset Management. “There're so many other factors coming into play, including monetary policy and geopolitical concerns, that it’s not enough to have just a very solid grasp of the macro environment.”


However, the report found that some central banks are willing to accept lower returns, with 42% saying they did so to maintain their traditional risk approach.

In comparison, 39% said they maintained an absolute level of return by diversifying into higher-yielding assets, while around 12% said their decision-making had not been affected.

By definition, reserve managers are more constrained than other asset owner peers, said Kevin Anderson, head of Investments for Asia Pacific at State Street Global Advisors.

This prevents them from not only allocating to lower-grade bonds, but also their ability to move their portfolio out of fixed income, he said.

Comparatively, sovereign wealth funds and public pensions have a longer-term horizon and are less concerned with short term liquidity. In response to a low interest rate environment, they have been able to move into alternative assets and equities to boost portfolio returns.


The respondents' changing interests could also reflect opportunities that they had spotted, rather than a flight from low-yielding, high-grade debt. 

The shift toward emerging market sovereign and supranational debt by these investors reflects wider trends such as the increased interest in China and sustainability, Anderson said.

“Because the overseas investment base into China’s sovereign debt has been very low, the scope to increase is high,” he said, adding that schemes such as Bond Connect have increased the openness and ability of foreign fixed income investors to increase their exposure to China.

Additionally, green bond issuance programmes by supranational banks provides investors the opportunity to apply a sustainability lens to their fixed income portfolios, he said. “Both [of these factors] give other reasons as to why we may be seeing some of these asset owners reducing their allocation to developed market sovereign debt.”

Read our previous stories and stay tuned for the upcoming pieces in this series which will provide in-depth coverage on China high-yields and ESG bonds.

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