OMFIF: How does the Swiss National Bank determine its investments and operations to be able to act in times of market stress, such as in March 2023?
Roman Baumann: Asset management at SNB is governed by the primacy of monetary policy. The first of the two main objectives of our investment policy is to ensure that our balance sheet can be used for monetary policy purposes at any time. In particular, SNB must be in a position to expand or shrink the balance sheet if necessary. We therefore hold significant parts of our portfolio in core government bond markets like the US and Germany.
Beyond that, we are working with a high level of diversification, therefore avoiding concentration risks. This makes the implementation of significant changes in the portfolio size due to monetary policy much easier. The second main objective is preserving at least the real value of the assets over the long term.
In addition to aiming for a high level of liquidity when defining our asset allocation, constantly improving trading capabilities is key. SNB split asset management into portfolio management and trading a few years ago. This enabled us to improve analytical capabilities and trading efficiency. Having a professional trading setup helps us implement large balance sheet changes without impacting markets.
OMFIF: The average duration of SNB’s foreign currency portfolio is 4.7 years. What are the main factors that determine the size and duration of fixed-income investments?
RB: The current breakdown of our strategic asset allocation is 64% in government bonds, a category that also includes cash held with central banks or the Bank for International Settlements. Then we have 11% invested in other bonds – that’s investment-grade credit as well as supranationals, sovereigns and agencies. That brings the total fixed-income allocation to 75%. Our investment policy is driven by long-term considerations. That speaks for a certain stability over time. Consequently, there was no major change in the strategic asset allocation in reaction to the situation of 2022.
The duration of the total portfolio currently is slightly below five years. There are limited fluctuations over time due to tactical or implementation considerations, but the strategic duration has been stable in recent years. Duration has been a good portfolio diversifier for us in the past. This is due to the fact that we are fully invested in foreign currency (no foreign exchange hedging) but report our portfolio performance in Swiss francs, which is a ‘safe haven’ currency. That means that in a risk-off environment, we suffer from losses on our foreign exchange exposure (due to Swiss franc appreciation) but benefit from gains on duration (due to decreasing global yields). And vice versa in a risk-on environment. Obviously, this playbook does not work in every situation, such as in 2022. But, in the long term, we still believe duration is a good diversifier for our portfolio.
OMFIF: SNB has a relatively high share of foreign exchange reserves in equities at 25% . How and why do you invest in this asset class?
RB: Equities play an important role in our strategic asset allocation. With the equity allocation of 25%, we improve diversification and increase expected returns.
Equities are managed passively according to a set of rules based on a strategic benchmark comprising a combination of equity indices in various markets and currencies – adjusted based on our exclusion policy. Thus, SNB does not overweight or underweight particular companies and sectors. The percentages of the individual shares in the portfolios are determined according to their market capitalisation. The principle of broadly replicating markets ensures that SNB operates as neutrally as possible in the individual stock markets and that structural changes in the global economy are also reflected in SNB’s portfolio.
Our investment universe is limited to public markets. We review our investment universe and asset allocation on an annual basis. In that context, we regularly evaluate potential additional asset classes to further diversify our portfolio. We have also looked at private markets in recent years, but we have decided to stay away, as private markets such as real estate, infrastructure or private equity do not fulfil the high standards for safety and liquidity that are required for our reserves portfolio.
OMFIF: SNB’s foreign exchange reserves are diversified across more than 10 currencies, including 37% in euros and 39% in dollars at the end of 2023. What are the benefits of this currency diversification?
RB: SNB’s foreign exchange reserves are by design invested in foreign assets. Hedging the foreign exchange risk versus the Swiss franc is not an option, as it would influence Swiss franc demand and might counteract monetary policy. This makes currency diversification our main risk management tool when it comes to foreign exchange risk.
The degree of currency diversification is limited by our need for liquidity combined with the large size of the portfolio. This partly explains why we hold large shares in the dollar and euro, which provide by far the most liquid capital markets. These currencies also play an important role with regard to a possible use of currency reserves in the role as lender of last resort. Other important currencies are the Japanese yen (8%) and sterling (6%). The remaining 10% is spread across a large number of different currencies.
OMFIF: What role does gold play in your portfolio?
RB: Our gold holdings have remained constant for many years at 1,040 tonnes. Given the unchanged size of our gold holdings, the relative share of gold within our currency reserves declined significantly with the balance sheet increase that started in 2009. We take into account the gold allocation when evaluating the risk of the currency reserves, but it is not part of the annual strategic asset allocation review.
OMFIF: Do any non-financial considerations shape your investment decisions?
RB: In general, SNB endeavours to spread its investments as widely as possible to avoid concentration risks and the market impact of transactions. That said, we have certain requirements relating to monetary policy considerations. In addition, SNB deviates from the principle of full market coverage in two instances.
First, we do not invest in shares of global systemically important banks due to possible conflicts of interest. Second, we want to make sure that our investment policy respects Switzerland’s fundamental standards and values. That is why we have an exclusion policy. Specifically, we do not invest in shares or bonds of companies that seriously violate fundamental human rights, systematically cause severe environmental damage or produce internationally condemned weapons. The exclusions are strictly rule-based, independent of financial considerations. We use the help of external service providers to identify the companies that fall under the exclusion criteria, and we exclude such companies from all internally and externally managed portfolios.
Generally, we look at environmental, social and governance risks and integrate them into our decision-making process in active fixed-income portfolio management, as we do with every other source of financial risk. The impact perspective of ESG is not accounted for in our investments or in asset management, as this is not part of our mandate. The Swiss constitutional and legislative authorities have not tasked SNB with using its investment policy to conduct structural policies, for example by favouring some economic sectors over others with our investments.
OMFIF: What are the main risks to SNB’s foreign exchange reserves?
RB: Exchange rates are the most important risk factor for the currency reserves. Other important risk factors include stock prices, interest rates and the gold price. Compared to these market risk factors, credit risk is less important. In fixed income, we limit our investment universe to investment grade. In addition, we hold large shares in core government bonds. Overall, 80% of interest-bearing investments are rated AA or higher.
This interview featured in OMFIF’s Global Public Investor 2024. Download the full report.
