Central banks in Asia – as elsewhere – are increasingly looking at new types of investment* with a view to diversifying their exposure and boosting returns.
This is raising various issues, one of which is the effect it is having on their relationships with their sovereign wealth funds. In some cases these are already tense, given the competition between the two entities; moves into new asset classes by central banks may be causing further strains.
“When a sovereign wealth fund is established, the experience has been that it is viewed as a competitor for management of a country’s reserves by the central bank.” says Brian Baker, Asia chief executive of bond manager Pimco. “In most countries there is very little interaction between the central bank and SWF. In many cases, the two report to different ministries of the government.”
Central banks have traditionally hired people right out of school, notes Baker, but are beginning to hire from the private sector, too.
Sovereign wealth funds are established with the intent of operating more like a private-sector institution and outside the bureaucracy of a government agency, he adds.
Asian SWFs often hire foreigners or overseas nationals and usually pay closer to private-sector rates, whereas central banks typically hire locals and cannot match private-sector salaries.
That said, central banks are starting to bring in people with backgrounds in global fund management, says Mark Jones, Asia-Pacific head of fixed income distribution at UBS. “You only do that if you’re starting to push the envelope,” he adds. “But they’ve probably had to move a bit on compensation.”
Such differences of course reflect the varying aims of the two types of institution. The broad objective of most SWFs is to use a country’s accumulated surplus capital to post better returns than a central bank might be expected to achieve, as a result of a more flexible investment mandate.
Ultimately a central bank’s purpose is to protect the integrity of its financial system, whereas sometimes SWFs have been set up without such a clear remit, and that can be a cause of problems.
Another issue is that allocating to third-party managers is no simple task for central banks. They tend to have strict guidelines on their use of fund firms and consultants, and these rules prevent moves into certain asset classes.
Ultimately, distinguishing the core objectives and operating frameworks for central banks in the region is beset with ambiguities, little transparency, and wide divergences in the assets and investment processes that are used, notes Peter Ryan-Kane, Asia-Pacific head of portfolio advisory at Towers Watson.
He suggests a two-step framework as a starting point: “Identify the source of foreign reserves, which are typically exogenous natural resources or systemic competitive factors, and whether some of these reserves have been partitioned, either within the central bank or in another companion fund. This can tell you quite a lot about the motivations and constraints that central bank staff are operating under.”
* See the forthcoming June issue of AsianInvestor for a feature about investment trends among Asian central banks.