Money & Banking

‘Reserve managers should look beyond the traditional approaches to maintain and enhance returns’

Our Bureau Mumbai | Updated on October 21, 2021

FILE PHOTO   -  REUTERS

First and foremost way to tackle the low yielding environment is to increase duration of portfolio, says RBI bulletin

Reserve managers can deal with the low yield environment by increasing the duration of their portfolios, investing in new asset classes, new markets and more active management of their gold stocks, as per the recommendations in an article in the Reserve Bank of India’s latest monthly bulletin.

In light of the likely persistence of various structural reasons for low yields, it is imperative that reserve managers look beyond the traditional approaches for the management of reserves to maintain and enhance returns, emphasised RBI officials Ashish Saurabh and Nitin Madan in the article.

The authors observed that the first and foremost way to tackle the low yielding environment to increase return would be to increase duration of the portfolio.

“The countries with adequate reserves have sufficient cushion to take on more duration risk. Increasing duration of the portfolio is the easiest and immediate step that can be taken to enhance return by some basis points,” they said, adding, this should be combined with increasing investments in longer maturities.

Investment in new products/asset classes

The officials suggested investment in new asset classes entailing investing in products beyond the traditional investment avenues. They noted that certain products may be novel in nature as surveys and anecdotal evidence do not suggest usage of these products by the reserve managers.

In this regard, the authors referred to the usage of investment products/ asset classes such as foreign exchange (FX) swaps; Repo transactions; dual currency deposits; equity index funds; and increase credit risk of the portfolio.

Active management of gold

The authors opined that active management of gold can yield a decent return to the Central banks beyond capital gains. Some of the avenues for active management of gold include gold deposits, gold swaps and gold Exchange Traded Funds (ETFs).

Central banks own almost 35,000 tonnes of gold (World Gold Council estimate) which is around 17 per cent of worldwide available above-ground stocks.

Investment in new markets

The RBI officials underscored that there are some countries which are relatively stable financially, are highly rated and offer better yields than some of the G7 countries. While these countries do not have very deep sovereign bond markets, they felt that a reserve manager could invest a small portion of their reserves in these markets and generate that extra yield.

Another way to generate higher return is lowering the credit rating requirement and investing in emerging markets which provide higher yield.

“This, however, entails a higher exposure to currency risk as their currencies can be volatile. To mitigate that, the reserve managers could explore investing in US/Euro denominated debt of these countries,” said Saurabh and Madan.

The various options through which a reserve manager could invest in these markets are direct investment; passive funds; ETFs; Separately Managed funds/Customised funds/ETFs; and Total Return Swaps.

The authors observed that the choice of investment strategy, however, would require to be tailored to suit the risk appetite, investment priorities, skill sets and operational capabilities of individual institutions.

The Reserve Bank of India Act, 1934 provides the overarching legal framework for deployment of reserves in different foreign currency assets and gold within the broad parameters of currencies, instruments, issuers and counterparties.

Currently, the law broadly permits deployment of reserves in investment categories such as deposits with other Central banks and the BIS; deposits with commercial banks overseas; debt instruments representing sovereign/sovereign-guaranteed liability with residual maturity for the debt papers not exceeding 10 years; other instruments / institutions as approved by the Central Board of RBI; and dealing in certain types of derivatives.

Published on October 20, 2021

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