Reserve managers battling low returns face tough choices

Will reserve managers stick with what they know or choose to diversify?

Global Public Investor, now in its 11th edition, uses OMFIF’s valued network of reserve managers globally to build a robust view of how $15tn of total international reserves are likely to be deployed across financial markets. This year, we surveyed 73 central banks with $5.4tn in international reserve assets.

For years, the story in reserve management was one of diversification. After the 2008 financial crisis, central bank reserve managers faced a decade of lacklustre returns. A significant number chose to diversify their international reserve holdings into a wider variety of currencies and asset classes. Equities, asset-backed securities, exchange-traded funds and even alternative asset classes such as real estate became investable assets for some central banks.

Then came successive crises: the Covid-19 pandemic, Russia’s war in Ukraine and subsequent energy shocks and inflationary episodes. The GPI surveys of 2022 and 2023 revealed a flight to safe assets and currencies and a risk-off approach to investment.

This year is a pivotal time for reserve managers. The 2024 edition of the GPI serves as a litmus test for central bank reserve management after markets were upended over the past four years. Do they expect a higher-for-longer rate environment? What are the implications for their asset allocation and currency compositions? Will reserve managers ‘stick’ with traditional reserve assets or opt to ‘twist’ by diversifying into a wider range of assets and currencies?

The results of the 2024 survey reveal some fundamental shifts in the reserve manager community but also little consensus on how they plan to approach markets in the future.

Reserve managers think inflation is slowly coming under control. Nearly all survey respondents (94%) expect the rate of inflation to be between 2% and 4% in major economies over the next two years. This is in stark contrast to last year when more than half (52%) anticipated inflation to be above 4%. But the battle is not over yet: 80% listed it as one of the top three factors impacting their investment approaches over the next 12-24 months.

Figure 1. Over a quarter of reserve managers looking to take on more risk

Do you expect to take a more active investment approach in the next 12-24 months, relative to the previous 12-24 months? Share of respondents, %

Source: Global Public Investor 2023-24

This year, the percentage of reserve managers saying they expect to go risk-on in their portfolios has doubled to 29% from 14% in 2023. In net terms (those looking to increase minus those expecting to decrease risk) this shift is even more striking at 25% compared to 0% last year. That’s not surprising, given that central banks struggled to generate inflation-adjusted returns in a benign market in 2023 (Figure 1).

In addition, the average portfolio share held in gold rose to 11% this year from 9% in 2023. This is in line with last year’s survey, which found that 14% of respondents would increase their allocation to gold over a 1-2-year period. Despite a record-high gold price and easing near-term inflation fears, a similar proportion (15%) expects to do the same over the next 12-24 months.

On currencies, cyclical factors are driving reserve managers towards the dollar. Over the next 12-24 months, a net 18% of respondents expect to increase their allocation to the dollar. That share is three times higher than it was a year ago and represents greater net demand than for any other currency, primarily due to the positive outlook for the US economy and comparatively higher interest rates. The euro is next highest at net 7%, suggesting that reserve managers will double down on traditional reserve currencies in the near term (Figure 2).

Figure 2. Dollar in highest demand over the short term

Over the next 12-24 months, are you planning to increase, decrease or maintain your exposure to the following currencies? Share of respondents, %

Source: Global Public Investor 2024

But appetite for the renminbi has soured. Nearly 12% of reserve managers are looking to decrease holdings in the next 12-24 months. A net 2% anticipate increasing their allocation over this period, compared to net 10% in 2023 and just over 30% in 2022 and 2021. That said, over a longer horizon, central banks expect to diversify towards the renminbi. In net terms, 20% anticipate adding to their renminbi holdings over the next 10 years, which is greater than for any other currency.

Finally, when it comes to incorporating environmental, social and governance factors into their portfolios, central banks are increasing their holdings of sustainable assets. The majority of central banks (67%) now invests in at least one sustainable asset. But while 40% of reserve managers report that they do not implement ESG, 28% of these invest in sustainable assets alongside conventional bonds that meet their eligibility criteria. This suggests they are doing so for reasons beyond sustainability.

We are grateful to the huge number of central banks around the world that share their data, enabling us to aggregate, dissect and analyse trends at the very heart of global finance.

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