Report on the Investment of Israel's Foreign Exchange Reserves in 2019

 

Mr. Andrew Abir, Deputy Governor of the Bank of Israel:

“The importance of the Bank of Israel’s foreign exchange reserves becomes clear at a time like this. The proper management of the reserves over the years and their notable balance going into the crisis now provide the Bank of Israel with degrees of freedom in managing the economic policies and in providing significant assistance to financial markets and to the economy overall in dealing with the coronavirus crisis. I emphasize that the investments by the Bank of Israel in the reserves portfolio are for the long term and that all investment decisions are made with at least a two-year outlook.”

 

  • Israel's foreign exchange reserves increased by $10.7 billion in 2019, from $115.3 billion at the end of 2018 to $126 billion at the end of 2019. 
 
  • The rate of return on the reserves portfolio in 2019 in terms of the numeraire was 6.1 percent, which is approximately $6.3 billion (mainly as a result of an increase in the value of equities and capital gains in bonds, in addition to income from interest and exchange rate differentials between the reserve currencies and the dollar.
 
  • The average return was 3.1 percent per year over the past 3 years, and 2.3 percent per year over the past 5 years.
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  • In the beginning of 2020, there was a sharp slowdown in real activity and an increase in risks, due to the outbreak of the coronavirus. In financial markets, this was reflected in steep declines in equities and corporate bonds, in sharp declines in government bond yields in the US and Germany and by a sharp increase in volatility in all financial assets. The steep declines in equity prices at the beginning of 2020 caused losses in the reserves portfolio, part of which were offset by capital gains as a result of the decreases in government bond yields.

The annual report on the investment of Israel's foreign exchange reserves for 2019 was published today (in Hebrew)[1]. The following are the main points in the report:

 

Level of the reserves

Israel's foreign exchange reserves totaled $126 billion at the end of 2019, an increase of $10.7 billion over the course of the year.  The level of the reserves relative to GDP remained within the stable range that has prevailed since 2009, increasing slightly to 31.9 percent in 2019.

 

Sources of the change in the reserves

Most of the increase in the reserves was due to profits, revenue, and rate differentials (mark to market) totaling $6.3 billion, and to the Bank of Israel’s foreign exchange purchases as part of the Bank of Israel's monetary policy, totaling $3.9 billion.

 

Composition of assets in the reserves

As part of the asset allocation for 2019, risk assets in the reserves portfolio were increased—equities were increased to 15 percent, and corporate bonds were increased to 8 percent.

At the end of 2019 64.9 percent of the reserves were invested in government assets, 11.8 percent in spread assets, 15.1 percent in equities, and 7.7 percent in corporate bonds.

 

Financial conditions

The financial conditions were supportive of the portfolio’s performance.  The yield to maturity on US dollar-denominated bonds, which account for the largest part of the reserves, declined, accompanied by an increase in the prices of risk assets, equities, and corporate bonds.

 

Return on the portfolio

The rate of return on the reserves portfolio in 2019 was 6.1 percent in terms of the numeraire, which is a basket of currencies, primarily comprised of the dollar and euro.  Over the past three years, the rate of return has averaged 3.1 percent per year, and over the past five years, it has averaged 2.3 percent per year.

 

 


 

 

 

Rate of return on the foreign exchange reserves portfolio, annual and multiyear perspectives, 2014–18

 

2019

Three years

Five Years

Actual portfolio return

6.12

3.08

2.29

Benchmark return

1.54

0.96

0.64

Excess return

4.59

2.12

1.65

 

 

Contribution of active management

The contribution of active portfolio management, the excess return over the risk-free portfolio (the basic benchmark), was 4.6 percent.  Equities made the most significant contribution among risk assets—3.4 percent. Duration also made a prominent contribution—0.9 percent.

 

Changes in guidelines

Following the increase in the level of the reserves in recent years, the Monetary Committee approved a change in the investment guidelines at the beginning of 2019, in order to give a greater weight to the goal of maintaining purchasing power also in the medium term.  The maximum risk level, CVaR(5%) to a one-year horizon, was raised from 400 basis points to 475 basis points, and the maximum share of investment in equities was raised from 15 percent to 17.5 percent (for more information see Box 1 of the Report on the Investment of Israel's Foreign Exchange Reserves for 2018).

 

Risk level in the portfolio

Even though the share of investment in risk assets in the portfolio increased, the volatility of the portfolio was less in 2019 than in the previous year, due to the decline in the volatility of the equity markets.

 

Corona crisis

At the beginning of 2020, there was a sharp slowdown in real economic activity and an increase in risks due to the outbreak of the coronavirus.  In the financial markets, this was reflected in sharp price declines in equities and corporate bonds, sharp declines in yields on government bonds in the US and Germany, and a sharp increase in volatility of all financial assets.

 

The sharp declines in equity prices led to losses in the reserves portfolio, some of which were offset by capital gains as a result of declining yields on government bonds.  Thus, the loss in the reserves portfolio as of the publication of this report does not exceed the maximum risk level. At this stage, it is difficult to know what the effect of the crisis will be on the financial markets or on the reserves portfolio by the end of 2020.  The coronavirus crisis illustrates the importance of a multiyear view of returns in the reserves portfolio, which reflects a multiyear average positive return on the investment in risk assets, despite the risk of losses in the short term.

 

 


[1] The English version will be published in a few months.​​