Bank of Lithuania’s financial assets: COVID-19 shock successfully managed after a profitable investment year
The Bank of Lithuania’s strategic asset allocation helped absorb the COVID-19 shock imposed on the global financial markets. The central bank achieved positive investment results in the first five months of 2020, while over the last three years (i.e. during its investment assessment period) it earned a total of €181 million. The negative interest rate environment remains the ultimate challenge in investing the Bank of Lithuania’s financial assets.
“The Bank of Lithuania manages roughly €4.5 billion of the country’s financial assets. Therefore, we take an extremely responsible approach in selecting and allocating investments in order to preserve their value and earn returns in the medium term, despite significant price fluctuations observed in the financial markets,” said Tomas Garbaravičius, Advisor to the Chairman of the Board of the Bank of Lithuania.
Investment return in January–May 2020 amounted to €136.4 million, even though price fluctuations in global financial markets were particularly pronounced due to the turmoil caused by the COVID-19 pandemic. Such results were achieved thanks to a progressive risk parity approach – at the end of 2017, the Bank of Lithuania became one of the world’s first central banks to implement this advanced method. The risk parity approach ensures equal distribution of investment risks across the largest possible number of risk sources. It not only mitigates the impact of short-term shocks on investment performance, but also helps achieve higher returns in the medium and long term, allowing for more profitable and riskier investments.
The Bank of Lithuania assesses its investment management results achieved over a rolling three-year investment period. It allows achieving higher return over the medium term by assuming a risk, the size of which should not exceed its one-year risk budget. The risk budget of the Bank of Lithuania’s investment portfolio amounts to €200 million. It is calculated for a one year period at a 95% confidence level and can only be completely used or exceeded once in 20 years.
In a challenging environment of negative interest rates, where highly safe securities almost surely result in financial loss, the Bank of Lithuania is constantly reviewing the range of its investment instruments, applying the most advanced investment management models and looking for possibilities to yield higher returns in the medium and long term. In 2019, the Bank of Lithuania started investing in mortgage-backed securities issued by US government agencies and increased its investments in debt securities issued by China, the United Kingdom and Canada, as well as in global equities. Moreover, it plans to further increase investment in foreign currencies accepting higher exchange rate risk, and also considers investment in foreign real estate funds.
The Bank of Lithuania manages the largest investment portfolio in the country: in 2019, the average value of its financial assets unrelated to monetary policy operations amounted to €4.5 billion. The gold reserves recovered after the restoration of Lithuania’s independence remain unchanged at 5.8 tonnes. Under favourable investment conditions, gold returns not only cover its storage costs but also increase return on financial assets. Last year, return on gold investment stood at €0.73 million. The main objective of holding financial assets is to ensure the stability of the Lithuanian and euro area financial systems and to provide a buffer against economic and financial shocks as well as other extraordinary circumstances.
Profits earned from the management of financial assets allow the Bank of Lithuania to cover its operating expenses and contribute to the financing of public expenditure – every year, a certain share the Bank of Lithuania’s total profits is transferred to the state budget. In 2020, this amount stood at €13.8 million. The central bank aims to gradually increase this contribution and ensure that all necessary risk provisions are built and a sufficient capital buffer for potential losses is accumulated.