Questions and answers on asset management
In addition to monetary policy, the SNB is also mandated with the task of managing the currency reserves. What does that mean exactly?
In order to implement its monetary policy, the SNB carries out monetary policy operations which affect the size and composition of its balance sheet (Questions and answers on the SNB's balance sheet). The assets side of the SNB's balance sheet is primarily composed of currency reserves; these are mainly gold and foreign currency investments (bonds, equities and investments at other central banks and the Bank for International Settlements). Swiss franc bonds represent a small proportion of the assets. The SNB manages the currency reserves and the Swiss franc portfolio, i.e. it invests on the financial markets.
Where are the rules for the SNB's investment policy laid down?
The provisions describing the task, the permitted investment operations and the responsibilities are set down in the National Bank Act (NBA; arts. 5, 9, 42 and 46). The 'Investment policy guidelines' of the SNB detail the transactions described in the NBA which the SNB may carry out in order to perform its investment policy tasks. These guidelines set out the investment policy principles, the investment instruments as well as the investment and risk control processes, and are issued by the Governing Board.
Who monitors the SNB's investment policy?
The Bank Council is responsible for the general oversight of the investment and risk control process (Questions and answers on the SNB as a company). It assesses the underlying principles and monitors compliance with them. The Risk Committee - which is composed of three members of the Bank Council - supports the Bank Council in this task. In particular, it monitors risk management. Internal risk management reporting is addressed directly to the Governing Board and the Risk Committee in the form of quarterly risk reports.
Who conducts the SNB's investment policy?
The Governing Board decides on the composition of the currency reserves and other assets. It also defines the requirements on the security and liquidity of investments, and the pool of eligible currencies, asset classes (e.g. bonds and equities) and issuers (e.g. sovereigns or corporates that issue bonds).
How does the Governing Board draw up the investment policy?
The SNB's assets are invested in accordance with the criteria of security, liquidity and return. The weighting of individual investment criteria is derived from the functions of the currency reserves. The Governing Board sets out the investment strategy, which is based on requirements specific to central banks as well as comprehensive risk/return analyses. The investment strategy covers the diversification of investments across different currencies and asset classes, and defines the leeway for active management at the operational level. The Governing Board generally decides on the investment strategy once a year.
How is the SNB's investment strategy implemented?
At the operational level, an internal investment committee decides on the tactical allocation. In other words, over the course of the year - and within the defined parameters - it adjusts the variables such as currency allocation and share or duration of the various asset classes, to take account of changing market conditions. The management of the individual portfolios is the responsibility of Asset Management. The majority of investments are managed by internal portfolio managers. External asset managers are used firstly in cases where there is an efficiency gain in doing so, and secondly to provide a benchmark against which to assess the performance of internal portfolio managers.
How are risks addressed in asset management?
A system of reference portfolios, guidelines and limits is used to manage and mitigate risks. All relevant financial risks on investments are identified, assessed and monitored continuously. Risk analyses take account of the fact that the SNB has a long investment horizon. To assess and manage credit risk, information from major rating agencies, market indicators and in-house analyses is used. Concentration and reputational risks are also factored in when determining risk limits. Compliance with the guidelines and limits is monitored daily.
What is the return on the SNB's investments made up of, and how is it recorded in the accounts?
It consists of interest income and dividends, as well as valuation adjustments resulting from exchange rate movements and market price changes. The resulting profit or loss is recorded in the statutory income statement of the SNB. The profit distribution is based on the provisions of the NBA and the applicable profit distribution agreement with the Confederation (Questions and answers on equity capital and profit appropriation).
Is the SNB's asset management aimed at achieving the highest possible return?
No. It is not the SNB's objective to achieve the highest possible return on its investments. Monetary policy has priority, so the security and liquidity of investments are more important. The criterion of security is taken into account by structuring investments so that at least the real value is preserved over the long term. A high degree of liquidity is ensured by investing the bulk of the foreign exchange reserves on the world's most liquid government bond markets. Nevertheless, in order for the Swiss franc investments to retain their value in the long term, sufficient income must be earned. Therefore government bonds in foreign currency investments are supplemented by other investment categories. When selecting assets, however, care is taken to avoid potential conflicts with the conduct of monetary policy.
What kinds of conflict can arise between monetary policy and investment policy?
In order to fulfil its monetary policy mandate, the SNB needs to be able to adjust its balance sheet at any time without limitation, and without having to take investment policy into account. For example, from an investment policy perspective it might seem appropriate to convert assets from one currency into another currency. However, this might bring the SNB into conflict with its monetary policy goals. In such cases, priority is always given to monetary policy.
As a central bank, the SNB has special knowledge about the Swiss economy and foreign exchange developments. How does the SNB ensure that this knowledge is not used improperly for asset management purposes?
The investment and risk control process is structured so as to avoid conflicts of interest between monetary policy and investment policy. For this reason, there is the greatest possible separation of responsibilities between monetary policy actions and investment policy operations. First, no insider knowledge acquired by virtue of the SNB's central bank status must be used in its investment activities. Second, investment activities must not send any unintentional monetary policy signals. For this reason, the SNB does not invest in Swiss equities or in bonds of Swiss companies.
Does the SNB's asset management distort the financial markets?
The SNB takes care to avoid its investments having any impact on the markets and currency developments in other countries. It therefore always acts in a prudent and market-neutral manner. The short-term absorption capacity of individual markets is an important criterion for the SNB. In summer 2012, for example, the SNB found itself facing very high inflows of foreign currency as a result of the foreign exchange market interventions related to the enforcement of the minimum exchange rate. It was able to place part of these funds on deposit at other central banks. In this way, it prevented market distortions or any impact on currency developments in other countries.
Which currencies and assets make up the SNB's foreign currency investments?
The majority of the SNB's foreign currency investments are in government bonds, bonds issued by foreign local authorities (e.g. provinces and municipalities) and supranational organisations, as well as corporate bonds, or are placed at other central banks. At the end of the first quarter of 2016, the proportion of equities was 20%. Just over 40% of the foreign currency investments are denominated in euros, and about 30% in US dollars. Other important investment currencies are the pound sterling, yen and Canadian dollar. In addition, the SNB holds smaller investments in the Australian dollar, Singapore dollar, Swedish krona, Danish krone and South Korean won and Chinese renminbi. The equity portfolio also contains stocks in other currencies. The SNB publishes the structure of its foreign currency investments on a quarterly basis.
Why are the foreign currency investments structured like this?
Since security and liquidity are the main priority for investments, the majority of foreign currency investments are held in government bonds. However, the SNB aims to achieve the broadest possible diversification of its foreign currency investments as regards currencies, issuers and instruments. This allows it to achieve higher returns over the long term, without having to take large fluctuations in earnings into consideration. Thus, for some time now, the SNB has also invested in corporate bonds and foreign-issued equities, and has recently expanded the pool of investment currencies.
Where can I find information on the current size and composition of the SNB's currency investments?
The SNB's balance sheet items, including the figures for foreign currency investments, are published on a monthly basis at the end of the following month on the SNB's data portal. Figures for the currency reserves are published shortly after the end of each month, as part of the data issued under the IMF Special Data Dissemination Standard. These figures are, however, provisional. Moreover, the foreign currency investments recorded in the SNB balance sheet may vary slightly from those reported according to the IMF standard, owing to differences in definitions. On a quarterly basis and at the end of each following month, the SNB publishes the breakdown of its foreign currency investments according to currency, asset class and rating (for interest-bearing investments) in conjunction with its interim results (currency investments and Swiss franc bonds). More information on the currency investments can be found in the SNB's Annual Report.
Does the SNB manage all of its investments from Switzerland?
No. Given the sharp expansion in foreign exchange reserves and the growing importance of the Asian financial markets, in 2013 the SNB opened a branch office in Singapore. This ensures a more efficient management of the SNB's Asian investments by internal portfolio managers in situ.
Does the SNB hedge the currency risk on its foreign currency investments?
Currency hedging would directly influence monetary policy, since any hedging would be equivalent to a purchase of Swiss francs against foreign currency. Consequently, the SNB does not hedge the currency risk on these investments, and has to bear the risk associated with exchange rate fluctuations. For this reason, the diversification and limitation of risk concentrations in foreign currency investments are very important for the SNB.
Why does the SNB hold just over 40% of its foreign currency investments in euros, and which member states were selected for these investments?
The euro area is by far the most important currency area for Switzerland's external trade. Consequently, the euro plays a major role in the currency allocation of the SNB's foreign currency investments. The SNB does not publish information on the share of investments accounted for by individual countries.
Is the SNB planning to diversify its portfolio further?
For this purpose, the SNB is continuously evaluating new asset classes, currencies and investment opportunities in advanced economies and emerging markets. The aim is to avoid risk concentrations. For example, in 2015, the SNB enlarged its investment universe of equities to include companies from emerging economies. It also invests in government bonds equivalent to just over CHF 2 billion on the local Chinese market.
How are these equity holdings compatible with what the SNB claims to be its most important investment criterion: security?
By ensuring the broadest possible diversification of its foreign currency investments, the SNB can reduce its currency risk and achieve higher returns over the long term, without having to take account of major fluctuations in earnings. These equity holdings improve both the potential return and the risk profile of the assets overall.
What criteria does the SNB use to select the equities in its portfolio?
In the case of its equity investments, the SNB replicates a combination of broad indices. Rather than pursuing positive or negative equity selection, it represents the international equity market as a whole. The SNB considers itself a financial investor, i.e. it deliberately avoids acquiring any strategic participations in companies. The investment policy is thus shielded from political considerations and the impact on individual markets is kept to an absolute minimum.
The SNB makes certain exceptions to the principle of full coverage of individual markets. In order to avoid conflicts of interest, it does not purchase shares in mid and large-cap banks. In addition, for ethical reasons, the SNB decided to exclude from its investment universe shares of companies which produce internationally banned weapons, seriously violate fundamental human rights or systematically cause severe environmental damage.
Does the SNB exercise the voting rights from its shares?
The SNB exercised its voting rights for the first time in 2015, focusing on mid-cap and large-cap companies in the euro area. When casting its vote, the SNB confines itself to aspects of good corporate governance.
Wouldn't it be in Switzerland's interest to transfer part of the foreign currency investments into a sovereign wealth fund, in order to achieve a better risk/return ratio and reduce exchange rate risk?
The SNB is not in favour of a sovereign wealth fund. When engaging in investment activities, the SNB must take account of monetary policy needs, and retain the flexibility to define the size and composition of its balance sheet. The assets in a sovereign wealth fund would be exposed to the same exchange rate risk as the SNB's currency reserves; even a much higher proportion of 'real' investments such as equities would offer no protection against value fluctuations. By investing part of the currency reserves in a well-diversified range of equities and corporate bonds, the SNB is able to exploit the positive contribution of these asset classes to the risk/return profile. At the same time, it retains the flexibility to adjust its monetary and investment policy to changing requirements.
What is the SNB's Swiss franc bond portfolio made up of?
This portfolio is invested passively, in highly rated bonds. The bond holdings therefore more or less reflect the composition of the market. Thus, the portfolio is made up of bonds issued by the Confederation, the cantons and municipal authorities. These bonds are purchased on the secondary market and must not be bought from an issue on the primary market (Questions and answers on the SNB's independence and its relationship with the Confederation). In addition, the portfolio contains bonds from other sovereign issuers, Swiss covered bonds (Pfandbriefe), bonds issued by international organisations headquartered in Switzerland, and foreign corporate bonds denominated in Swiss francs. The entire Swiss franc portfolio represents less than 1% of the SNB's assets.