Portfolio and risk management for central banks and sovereign wealth funds

BIS Papers  |  No 58  | 
13 October 2011

This volume is a collection of papers presented at the Third Public Investors Conference, which was jointly organized by the Bank for International Settlements (BIS), the European Central Bank (ECB) and the World Bank (WB). This event, which took place on 2-3 November 2010 at the BIS's head office in Basel, brought together over 80 participants from more than 50 institutions comprising central banks, sovereign wealth funds and public pension funds.

The main aim of the current as well as previous Public Investor Conferences has been to create a forum where academics and private and public sector investment professionals can meet to discuss and ponder the issues of specific relevance to public sector investors. It is well recognized that public institutions differ markedly from their private sector peers in their investment activities. Investment rationales, preferences, eligible investments, governance structures and accountabilities as well as aspects relating to the availability of human and technical resources distinguish public investors. These idiosyncrasies have profound effects on how portfolio and risk management activities are organized and performed in public sector institutions.

Having discussed initial reactions to the financial crisis at the Second Public Investors Conference held at the World Bank in Washington DC, the 2010 Conference focused on how public investors are revising asset allocations and investment processes in response to the new financial market environment. Faced with high growth rates in foreign reserves and other pools of publicly managed funds, public investors are beginning again to discuss broader diversification of assets. Judging from the contributions to and discussions at the conference, central banks are concentrating their search for diversification opportunities on investment alternatives among sovereign obligations, including inflation-linked instruments and investments denominated in currencies other than those represented in the SDR basket.

At the same time, public investors are becoming more aware of possible tension between what is optimal at the level of an individual investor and what might be required from the perspective of stability of financial markets. In terms of methodologies and techniques, similar to other institutional investors, public investors have accelerated efforts to develop and implement approaches for the management of market and credit risk that take on board lessons from the financial crisis. Also, further improved techniques for and oversight of active management of public funds received considerable attention at the conference.

In his keynote address, Professor Robert Z Aliber (International Economics and Finance, Booth School of Business, University of Chicago, emeritus) set the stage for the conference by describing four cycles of cross-border money flows since the early 1970s. These flows led to increases in the values of the currencies of the countries that experienced these money inflows, increases in their current account deficits, and increases in asset prices in these countries. These money inflows primarily financed increases in consumption spending. The countries that experienced these money inflows were in the "sweet spot" as long as the increase in indebtedness was larger than the interest payment on the indebtedness. These patterns of cash flows were not sustainable, and when they reversed, financial crises often followed.

JEL classification: E58, F33, G11