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Speeches & Transcripts October 12, 2017

How global headwinds and tailwinds impact official asset and reserve managers

Thank you, David, for your kind introduction.  Let me start by welcoming everyone.  My Colleagues and I in the World Bank Treasury are delighted that you made out time from a busy annual meeting schedule to attend this event especially so early in the morning.  We are also pleased to offer this morning’s discussion in collaboration with OMFIF.  This event is one of the many events, workshops, and conferences organized under the World Bank Treasury’s Reserves Advisory and Management Program(RAMP).  “In an uncertain world” we believe that it is of great value to provide fora for an exchange of views and experience.

As you, may be aware, the World Bank Treasury has been supporting central banks and other official sector asset managers through RAMP for the past 16 years.  RAMP started with three clients and USD 650 million assets under management.  It has steadily grown to a global community of 65 institutions, for whom we manage USD 21 billion and provide training and advisory services using our unique ‘practitioner to practitioner’ model.  Thanks so much for your enormous trust in my colleagues and I.  We promise that we will continue to do our utmost best to exceed your expectations.

We are of the view that central banks are the heart of a country’s economic and financial ecosystem.  In the case of central banks in developing economies, they are the vanguard of financial sector development and the exemplar for other public sector institutions.  As such, the institutional development of central banks, focused on prudential and sound policies, along with ethical and financial integrity, tightly integrates our RAMP enterprise with the World Bank’s twin goals of ending extreme poverty and boosting shared prosperity.  RAMP aims to foster its clients’ capacity in asset-management through knowledge-transfer, technical training and customized collaborations.  We complement a central bank’s efforts to establish and continuously improve the prudential stewardship of its foreign exchange reserves.   In turn, these activities support each central bank in competently executing its core mission of monetary and financial stability, thereby maintaining the credibility needed to preserve its independence, and support the country’s economic and social progress.

The sharing of knowledge and experience is of utmost importance in a world that is still characterized by uncertainty about the direction of policies; where economic growth expectations remain unclear; in which elections shift market paradigms and expectations; and where a significant share of the populace in the developed world is rejecting free trade and globalization and content to vote for disruptive leaders and referenda.

So where are we today?  Years of extraordinary monetary stimulation in the developed world are beginning to bear fruit as the global economy is currently experiencing the most synchronized rebound in growth since the global financial crisis.  In the US, greatly improved labor markets and an economy that has been growing at or above potential for a number of years have rekindled the debate about the pace of eliminating monetary policy accommodation, in spite of continued low inflation.  As such, the FED delivered 3 rate hikes in this tightening cycle, signaling that there is more to come and recently starting the process of balance sheet reduction.  In Europe, the cyclical upswing in growth since the second half of last year has been broad-based and has shifted the rhetoric this year away from populism and the existential threat it poses to Europe’s stability towards discussions of a timetable for the end of Quantitative Easing (QE) by the ECB.  Obviously, there are uncertainties associated with market expectations. 

For emerging markets, while commentators tend to lump these economies into a single category, policy stances, volatilities and vulnerabilities vary greatly between countries.  At a high-level though, growth conditions have improved in most emerging markets supported by a steady growth environment in China and commodity prices that seemed to have found a floor, in addition to easy monetary conditions in the developed world.  Having said that, the prospect of potential interest rate increases in the developed world, in the coming years, continues to pose potential challenges for emerging markets, both in terms of capital and portfolio flows as well as debt sustainability.

Given the high degree of uncertainty and the difficulty of anticipating correctly the outcome of political events such as elections or political approval processes in respect of a successful passage of tax reforms in the US and BREXIT negotiations in Europe, what should reserve managers do?  The following come immediately to mind:

(a) First, go back to basics:  Be focused on your core and medium-term objectives through asset allocation and create resiliency through calibrating your institution’s risk profile with your asset allocation.

(b) Maintain an adequate liquidity profile that preserves the ability to react quickly, as needed, to significant changes in the external environment.  

(c) focus on strengthening your risk measurement and management.  Volatilities and crises in the recent past have revealed that risk models are only as good as the data they rely on and often this data reflects primarily the recent past. 

(d) Be aware of these biases and fallacies. 

(e)  from an active risk perspective, ensure that your risk budget remains in line with your institution’s risk profile. 

(f) Unfortunately, as all of us know, there is no free lunch. And while all of us are tempted to augment returns by, for example, extending duration or moving further along the credit curve, we must cautiously recognize that there is greater risk attached to these choices.

(g) Finally, manage the expectations of all stakeholders.  While expectations for returns may be marginally increasing in a world where risk premia are priced tightly, we should acknowledge and inform our stakeholders that in nominal terms in the short run, sovereign fixed income assets may generate negative returns over the short run as coupons are not high enough to provide much of a buffer against even modest losses in mark-to-market. And, diversifying into credit is no panacea. Credit spreads are tight and moving into credit does necessitate adequate experience and skillset. Transparency may continue to be the best disinfectant.

As you may know, the World Bank Treasury manages about USD 180 billion including USD 27 billion of pension assets invested across public and private asset classes.  Although we are not a central bank, and our risk profile is uniquely determined by our mandate and objectives, we too are sticking to our basics.  Subject to our asset allocation and prudential risk- budget, we are tactically approaching the market and are expressing the following main active views (a)  investing opportunistically in high-grade Sovereign, Supranational and Agencies(SSAs), exploiting relative value opportunities primarily in the one-and five-year sectors, on either a hedged basis or versus Treasuries; (b) due to the increased uncertainty (associated with US fiscal policy,  North Korean tension and Caribbean hurricanes), the short end of the US Treasury curve has significantly flattened, and as the economic data is still very supportive, we believe that the risk-reward for steepener curve-trades remain constructive; and (c) we continue to see limited value in term and volatility premia at current levels, relative to LIBOR.  While these specific observations are not meant to imply any guidance or relevance of how your institution may tactically position, I share them only as illustrations of how properly risk-calibrated strategies can still be implemented even in the most uncertain of times.   

Let me also bring to your attention that the World Bank’s Pension Fund managed by Treasury is a signatory to the United Nations backed Principles for Responsible Investments.  As a multi-asset class investor, we strive to incorporate the consideration of environmental, social and governance (ESG) factors into our investment processes.  We actively engage with our over 200 core external asset managers to raise awareness of ESG issues as risk factors and encourage them to take into account the long-term sustainability of investments.  We believe that ESG due diligence is key for official sector asset managers to start to give attention. Our work in this area, has provided us with many insights and experience that we are happy to share with our clients and other asset owners in order to promote a more sustainable financial system.

In closing, I would like to thank again our partners from OMFIF, and recognize my colleagues in RAMP for their hard work in organizing this event.  I am certain that given the caliber of our distinguished panel, that the panelists will help us shed more light on the external factors that could affect decision-making of official sector asset managers and all of you. 

I wish you all a fruitful discussion. Thank you.