In 2021, the net assets of exchange-traded funds (ETFss) stood at nearly $10 trillion, after inflows of over $1 trillion.
ETFss have gained popularity with investors and may be of interest to central bank reserve managers seeking safety, yield and liquidity. Central bank mandates vary, but all reserve managers must navigate a complex new economic environment.
Central bankers around the world are facing high inflation. GDP growth in many countries has been revised down. Market uncertainty persists.
In the wake of the Covid-19 pandemic, providing insurance against external shocks has remained the most important investment objective for reserve managers. The conduct of the exchange rate policy and the service of the external debt are the second and third most important.
In its 2021 survey of 119 central banks, the World Bank also found that central bankers were adapting their approaches. They perceived a potential need for higher reserves and placed more weight on security and liquidity. They also reduced duration and increased diversification.
Today, as the climate crisis unfolds, more and more central banks are adding sustainability as a key objective. ETFss can be a way to gain exposure to assets in pursuit of that goal.
As part of this thematic report, central bank asked reserve managers about their perspective on the short-term and long-term investment landscape, ETFss and details of their strategies.
A key theme was that ETFss are an investment vehicle and a lot depends on the underlying assets. Market volatility is expected to persist, at least in the short term. Risk and return are considered a characteristic of market factors.
Reserve managers said the benefits of using ETFss include profitability, ease of access, tax advantages, operational simplicity and liquidity. However, asset managers must also weigh the expense ratio – the measure of a fund’s assets needed to cover operating expenses that impact returns and tracking error – and the extent to which a ETFs tracks its benchmark.
Uncertainty also remains as to how ETFss behave when markets crash. Issuers point to price discovery that ETFs markets activated during the “race for liquidity” of March 2020, but “we do not know how some ETFss would behave in times of acute market stress, if their holders all decided to liquidate their positions at the same time,” said Malick Dioume of the Bank of Haiti. central bank.
In the complex world of sustainable investing, benchmark data providers also shape the nature of ETFss, an issue explored in another section of this report.
At the end of the day, ETFss, in their thematic design and the arbitration mechanisms that govern their behavior, also reflect the principles of their issuers.
We hope this report will be informative for central bank reserve managers when deciding whether to use ETFss will help them fulfill their mandate.
This feature is part of the Central Banking focus report, ETFss in reserve management 2022