Central Bank Reserve Management

Why the Short-End usually pays

I have managed a large amount of central bank reserves and associated mandates in my early career. The portfolio sizes are typically massive, on average 1-5 billion USD equivalent. Guideline restrictions are very damn tight, and risk parameters limiting in what you can do as a portfolio manager. Fees are peanuts, understandably so. These are basically foreign currency reserves (mostly USD) held by foreign central banks and official institutions.

The given benchmarks were usually all very similar. They all opted for either 1-3 year or maximum 1-5 year benchmarks. That means generally short-dated treasuries or equivalent maturity non-treasuries if allowed. Now, keep in mind that those reserve managers don’t have a full flex, high volatility mandate. Why? They aren’t really allowed to lose money. Those reserves are there for a purpose and need to be in highly liquid securities.

Central banks could have obviously opted to manage those assets themselves, and many do. The reason why they give it away to asset managers is simple. Information exchange. They are highly demanding clients, but they are loyal and very long-term if you manage to get them on board.

I had a few trips in my earlier days to some quite exotic places in the world to pitch investment capabilities. There were some fun stories which I will be happy to share at some other point. Let me tell you, though, that conducting a portfolio review with a military attache who keeps a gun on the table really sharpens your focus.

Now, let’s go into more detail as to why they choose front-ends.