In ultra-low interest environment, Bank of Lithuania invested profitably, but future losses are possible
By investing its financial assets, in 2016 the Bank of Lithuania got a nearly EUR 48 million in return, i.e. a third more than in 2015. Earnings from gold investments last year were the largest over the last 9 years. Nevertheless, the investment environment is especially complicated, so the Bank of Lithuania implements additional measures, which would allow control of potential losses in the future.
‘Investment results confirm that the solution to manage financial assets flexibly was effective – we have expanded the investment arsenal and geography, extended the duration and diversified risk even more. However, the interest rate rise cycle, which started in the US and will sooner or later start in Europe, forces us to prepare for new challenges. Rising interest rates would lead to losses in part of our investment portfolio. Moreover, investment performance is greatly affected by stock price and exchange rate developments,’ says Tomas Garbaravičius, Member of the Board of the Bank of Lithuania.
Having renewed its own (not related to monetary policy) financial assets management policy at the end of 2013 and successfully implementing it, over the past three years the Bank of Lithuania earned nearly EUR 200 million from reserves investment.
As the investment environment changed, the structure of strategic investments was changed as well. With the interest rate on particularly safe investment being close to zero or even becoming negative, the Bank’s investment portfolio has been supplemented with corporate bonds as well as shares, which in the long-term allow seeking a higher return. Investment in the debt securities of the Chinese government started; it was also invested in in the UK, Canada, US. In 2016, the first external manager of the Bank of Lithuania’s financial assets was invoked – the International Bank for Reconstruction and Development (referred to as the World Bank), which was entrusted to manage a certain small portion of the Bank of Lithuania’s financial assets.
The Bank of Lithuania’s reserves comprise 5.8 tonnes of gold, held in the Bank of England in London. Under favourable conditions, gold is invested as deposits or by concluding gold swaps. This way, in 2016 it was not only saved on gold custody costs, but also record profit was earned – slightly more than EUR 2 million.
‘Our really good reserve investment results were achieved in a complicated investment environment, which at least in the medium term will not be more favourable. Having assessed possible risks, in the medium term we aim to earn an investment return that would exceed the Bank of Lithuania’s operational costs. In addition, we are improving investment and risk management and are investing in such a way thatevenunder unfavourable conditions the possible losses would most likely not exceed EUR 100 million’, says Tomas Garbaravičius.
Taking into account the current investment environment, the strategic trends of the operation of the Bank of Lithuania for 2017–2020, approved at the beginning of the year, foresee the implementation of innovations in financial asset management. In the next few years, the Bank of Lithuania plans to start investing in US corporate bonds, as well as inflation-linked bonds and mortgage-backed securities. Quantitative investment strategies will be created and developed.
As the country’s central bank, the Bank of Lithuania manages the largest investment portfolio in Lithuania. In 2014–2016, the average size of the Bank of Lithuania’s own financial assets amounted to EUR 3.3 billion. and, with the improved investment environment, could be increased to nearly EUR 5.9 billion. Over the past three years the average annual return on financial assets (excl. change in gold price) was 1.70 per cent, while total return – 5.3 per cent.
The Bank of Lithuania’s own financial assets, not related to monetary policy, is managed with the aim to diversify investment risk and increase potential investment return over a three-year investment horizon. To achieve these objectives, the Bank of Lithuania invests in investment grade debt securities of central governments, government agencies and international organisations as well as in the corporate debt and equity securities (shares) of developed countries.