Emerging market central banks have pioneered

Emerging market central banks have pioneered investment tranches to generate greater returns and developed markets are exploring their ability to follow suit In last year’s report we identified that emerging market reserve managers were developing an investment tranche, to diversify away from low- yielding government bonds and generate better risk adjusted returns. This year, low interest rates again led EM central banks to increase the level of the investment tranche and invest in riskier asset classes, targeting higher returns over time to support future reserves adequacy. Additionally, certain emerging market central banks had recently relaxed fixed or managed exchange rate regimes, allowing for greater freedom to allocate reserves to the investment tranche. As central banks (including DM Low FME) expand the size and risk asset exposure of the investment tranche, they also are assessing how to best manage risk, return and cost, particularly where higher levels of reserves and depth of internal resources support developing internal management expertise. Central banks have a range of resources available in making their assessments, including case studies and performance data from those EM central banks reaching the end of the first cycle of risk assessments, with many respondents indicating their willingness to share such information with peers. While we note the long timeline for the first generation of EM central banks to establish their investment tranches (an average of 22 months across our emerging market sample), the availability of peer support and information sharing has the potential to create a positive network effect supporting future implementations. Central banks acknowledge the need for external support as they move out the risk spectrum to corporate bonds and equities Typically, the development of the investment tranche starts with asset-backed securities (figure 32). The majority of central banks are comfortable managing investment grade government debt internally and perceive high grade asset-backed securities as comparable in terms of management requirements and risk profile. However, reserve managers are moving up the risk curve, primarily seeking to increase allocations to equities and corporate bonds (figure 33). Many respondents acknowledged they do not yet have the necessary internal governance process or risk management capability to manage these investments internally. Respondents also noted that while reserves management peers were able to assist them in planning the development of the investment tranche, their support often lacked technical detail on investment governance and asset management infrastructure. 41 Fig 32. First investment tranche asset class (% citations) Asset-backed Equities Corporate bonds Alternatives securities 54 23 20 3 | Sample comprises of central banks only. Sample=30. Fig 33. Investment tranche asset class future increase (% citations) Equities Corporate bonds USagencyMBS Agencies, Multilateral debt, Supranational debt Bf Sample comprises of central banks only. Sample=30. HOUSE_OVERSIGHT_026721