Report on the Investment of Israel's Foreign Exchange Reserves in 2014

The annual report on the investment of Israel's foreign exchange reserves for 2014 was published today[1], the following are the main points in the report:
 
v  Israel's foreign exchange reserves increased by about $4 billion in 2014, compared with an increase of about $6 billion in the previous year, and at the end of 2014 they totaled $86.1 billion.[2]
 
v  In 2014, the Bank of Israel purchased $7 billion. Half the sum was purchased within the framework of the Bank of Israel’s intervention intended to moderate exchange rate volatility which is not in line with fundamental economic conditions in Israel, and the other half was purchased within the framework of implementing the plan to moderate the effect of natural gas production on the exchange rate. The change in the reserves that is attributed to interest income, capital gains, and exchange rate differentials between the dollar and the currencies in which the reserves are invested, reduced the reserves by around $3 billion. This was mainly the result of the strengthening of the dollar vis-à-vis the other currencies in which the reserves portfolio is held.
 
v  At the beginning of the year, the investment policy guidelines for the foreign exchange reserves were revised—the maximum permitted allocation to equities was increased to 12 percent, from 6 percent, and investments in corporate bonds were approved, to a maximum of 6 percent of the reserves. The guidelines were updated following the definition of the reserves’ risk profile that was determined toward the end of 2013. The risk profile then was defined so that given the worst 5 percent of possible outcomes the average loss would not exceed 400 basis points, in a one-year horizon (CVaR5%). During the course of the year, the CVaR5% of the reserves portfolio ranged around 300 basis points.
 
v  Within the framework of the process of the strategic allocation of the reserves portfolio for 2014, it was decided to allocate 8 percent to equities and the remainder to bonds; to increase the portfolio’s duration from 10 months to 12 months; and to include a corporate bond component in the reserves. Accordingly, toward the end of the year, one percent of the reserves were invested in US corporate bonds as a pilot investment.
 
v  This year, the holding period rate of return on the reserves, in terms of the numeraire[3], was 1.28 percent, of which 0.22 percent was the benchmark return and 1.06 percent was the active management contribution. The active management contribution, which was double the previous decade’s average, is attributed primarily to investment in equities, which contributed 67 basis points. Investing the reserves in longer maturities, while diversifying assets across the curve differently than in the benchmark, contributed about 35 basis points to the active management return. This was due to a decline in yields in countries whose currencies are included in the numeraire, which generated capital gains.
 
v  In continuation of the process, which began in 2013, of reducing the exposure of the reserves to currencies and assets of commodity-oriented economies, the share of strategic exposures in the reserves portfolio in 2014 remained low, similar to that at the end of 2013.
[1] The Hebrew version of the report was published today. The English version will be available within several weeks.
[2] The level of the reserves includes allocations of Special Drawing Rights by the International Monetary Fund to member countries (SDR Allocation) and Israel's balance in the Reserve Tranche of the Fund. At the end of 2014 these totaled $1.8 billion. For more on this issue, see the Bank of Israel's Financial Statements for 2014.
[3] The numeraire is a currency basket in which the foreign exchange reserves are measured.