Central banks faced many challenges in the second year of the Covid-19 pandemic. But one part stood out in terms of supporting official institutions in their efforts to diversify foreign exchange reserve portfolios and maintain stable risk exposures: BNP Paribas Asset Management (BNPP A M).
The European asset manager with a strong presence in North America has supported several reserve managers in the adoption of new strategic asset allocations (SAAs) compatible with higher yields. It also helped them update their investment frameworks to include environmental, social and governance aspects (ESG) Criteria. Besides, BNPP A M continued to leverage its expertise in WE securities backed by mortgages (MBS) to help clients navigate a changed regulatory and market landscape. These efforts were rewarded with an increase in assets under management from new clients and an increase in existing mandates.
Key to its success is the flexibility of the asset manager’s team, which can tailor its capabilities to serve both large and small reserve managers.
“Our customers face an enormous responsibility in managing their country’s reserves,” says Johanna Lasker, Managing Director for North America and Global Head of Official Institutions at BNPP A M. “We’re able to partner with them, support them when they consider adding a new instrument, embarking on ESGor by adding ETFss [exchange-traded funds] for the first time.”
This is illustrated by the relationship developed over the past year with a central bank in southern Europe. This institution sought to reorganize its SAA because he was ‘concerned about the long-term risk and reward profile’ of his investments, a portfolio manager told the central bank central bank. Having a legacy fixed income portfolio in a low yielding environment, the central bank wanted to explore investments in other asset classes and also add a ESG dimension to its management of reserves. BNPP A M provided a portfolio optimization exercise to explore the best possible alternatives.
“They explained to us right away what we could expect from this exercise, and they provided us with a timeline,” explains the portfolio manager. “They actually went above and beyond what we asked of them.”
The exercise was to be completed in just over six weeks, in order to obtain a review by the investment committee and the central bank’s board of directors on the modification of the SAA. This put all officials under significant time pressure. However, during this turbulent period, BNPP A M collected all the details of the portfolio and investment guidelines, organized workshops, conference calls and operated with great flexibility, emphasizes the portfolio manager.
“Central banks have a long experience of investment strategies. When you propose changes to them, you really need to help them understand where the impact will be. And above all, we must avoid creating undesirable risks,” explains Julien Halfon, head of pension solutions, BNPP A M.
BNPP A M started to measure asset allocation in terms of expected return, level of risk and resistance to market shocks. With this information, the team created a profile.
“Once we decided to change the allocations to the client’s existing asset classes, we could see the risk/reward profile change,” says Halfon. “When determining how the profile was going to evolve, the client could feel that everything was under control.
The French asset manager was also willing to adapt its models (which largely deal with long-term scenarios of 10 to 20 years) to meet this central bank’s short-term scenarios of one to three years.
“They tweaked their systems a lot to meet our needs, and they introduced us [with] a whole project covering exactly what we wanted”, explains the portfolio manager. “And they did it in time.”
Besides, BNPP A M provided clear and understandable reports to board members, who lacked direct market and asset management expertise, but ultimately had the final say on the SAA.
The exercise aims to optimize diversification by measuring which asset classes work best within the existing framework. “For example, inflation-linked bonds provide great diversification when you place them in a fixed-income bond portfolio,” says Halfon. “The result is that the client immediately notices a reduction in the expected and tested risk.”
The Reserve Management Department has obtained Board approval to adopt the new SAA. “We aim to hold nearly 20% of the portfolio in alternative assets to fixed-income securities over a three-year horizon,” specifies the portfolio manager. Ultimately, portfolio optimization helped the central bank move from its traditional investment frameworks, which were risk-return oriented and primarily invested in fixed-income securities, to a world where risk, yield, liquidity and ESG.
the WE The mortgage market has faced specific problems due to the Covid-19 pandemic. Notably, investors needed to understand how the new relief measures — including temporary suspensions of mortgage payments — were affecting their investment portfolios.
Additionally, the Federal Reserve MBS purchases stabilized the market in the early stages of the pandemic, pushing prices higher. As part of its stimulus during the pandemic, the Fed bought $120 billion in securities per month, $80 billion in Treasuries and $40 billion in MBS. As a result of these interventions and purchases made in the wake of the global financial crisis, the Fed MBS holdings now stand at nearly $2.7 trillion, according to official data. This has displaced other buyers, and as the Fed withdraws its stimulus, reserve managers must consider the consequences this could have on the market.
These pandemic-related measures have added to the difficulties inherent in managing MBS from outside the WEan already fragmented market in which States have different legislation which hinders comparisons between MBS swimming pools. It is therefore more difficult to establish a benchmark for assessing performance and risk. Moreover, it is more difficult to model prepayment risk, since prepayments do not depend solely on macroeconomic factors.
“If you want to do it internally, you really need an analyst working on all mortgages, someone who knows how to analyze the market,” explains the head of the Mediterranean central bank. “And you also need a system that supports that asset class – our platform is not able to handle that asset class.”
Due to these complexities, this central bank recently updated its MBS mandate with BNPP A M at $1.7 billion.
“BNP not only provides us with the tools to reap higher yields through MBSbut also regular meetings [during which] we get valuable and broader insights for [help] make decisions about our portfolio,” the manager adds.
The Central Banking Awards were written by Christopher Jeffery, Daniel Hinge, Dan Hardie, Victor Mendez-Barreira, Ben Margulies and Riley Steward