Asset manager: BNP Paribas Asset Management

Central banks have faced many challenges during the second year of the Covid-19 pandemic. But one party has stood out in terms of supporting official institutions in their efforts to diversify foreign exchange reserves portfolios and maintain stable risk exposures: BNP Paribas Asset Management (BNPP AM).

The European asset manager with a strong North American presence has assisted several reserve managers in adopting new strategic asset allocations (SAAs) consistent with higher returns. It has also helped them to update their investment frameworks to include environmental, social and governance (ESG) criteria. Additionally, BNPP AM has continued to harness its expertise in US mortgage-backed securities (MBS) to serve clients in navigating a changed regulatory and market landscape. These efforts have been rewarded with more assets under management from new clients and increased existing mandates.

Key to its success is the flexibility of the asset manager’s team, which can tailor its capabilities to serve large and smaller reserve managers alike.

“Our clients face a tremendous responsibility managing the reserves of their country,” says Johanna Lasker, chief executive for North America and global head of official institutions at BNPP AM. “We’re able to partner with them, providing support when they’re thinking about adding a new instrument, getting into ESG, or adding ETFs [exchange-traded funds] for the first time.”

This is exemplified by the relationship developed over the past year with a southern European central bank. This institution sought to revamp its SAA because it was “concerned about the long-term, risk-and-return profile” of its investments, a portfolio manager at the central bank tells Central Banking. Having a legacy fixed income portfolio in a low-yield environment, the central bank wanted to explore investments in other asset classes and also add an ESG dimension to its reserve management. BNPP AM provided a portfolio-optimisation exercise to explore the best possible alternatives.

“They immediately explained what we could expect from this exercise, and they provided us with a timeline,” says the portfolio manager. “In fact, they went beyond what we asked them for.”

The exercise needed to be completed in just over six weeks, to secure a review by the central bank’s investment committee and board of directors on modifying the SAA. This put all officials under significant time pressure. Yet, during this hectic period, BNPP AM collected all the details from the portfolio and investment guidelines, organised workshops, conference calls and operated with great flexibility, the portfolio manager stresses.

“Central banks have a long experience with investment strategies. When you offer them change, you really need to help them understand where the impact is going to be. And you especially need to avoid creating unwanted risk,” says Julien Halfon, head of pensions solutions, BNPP AM.

BNPP AM started to measure asset allocation in terms of expected return, the level of risk and the resilience against market shocks. With this information, the team created a profile.

“Once we decided to change allocations to the client’s existing asset classes, we could see the risk/return profile changing,” says Halfon. “When determining how the profile was going to evolve, the client could sense that everything was under control.”

The French asset manager was also willing to adapt its models (that deal largely with long-term scenarios of 10–20 years) to address this central bank’s shorter-term scenarios of one to three years.

“They did tweak a lot their systems in order to respond to our needs, and they presented us [with] a whole project covering exactly what we wanted,” says the portfolio manager. “And they did it on time.”

Additionally, BNPP AM submitted clear and easy-to-understand reports for members of the board of directors, who lacked direct expertise of markets and asset management, but ultimately had the final say on the SAA.

The exercise seeks to optimise diversification measuring which asset classes work best within the existing framework. “For instance, inflation-indexed bonds bring quite a lot of diversification when you put them into a portfolio of fixed income bonds,” says Halfon. “This results in the client immediately seeing a lowering of the expected and tested risk.”

The reserve management department secured the board’s approval to adopt the new SAA. “We are aiming to have almost 20% of the portfolio in alternative assets to fixed income over a three-year horizon,” says the portfolio manager. Ultimately, the portfolio optimisation helped the central bank to transition from its traditional investment frameworks, focused on risk-return and mostly invested in fixed income, into a world with risk, return, liquidity and ESG.

MBS services

The US mortgage market faced specific issues due to the Covid-19 pandemic. Notably, investors needed to understand how new relief measures – including temporary suspensions of mortgage payments – affected their investment portfolios.

Additionally, Federal Reserve MBS purchases stabilised the market in the initial stages of the pandemic, boosting prices. As part of its stimulus during the pandemic, the Fed purchased $120 billion in securities per month, $80 billion in Treasuries and $40 billion in MBS. As a result of these interventions, and purchases carried out in the wake of the global financial crisis, the Fed’s MBS holdings now stand at close to $2.7 trillion, according to official data. This displaced other buyers, and as the Fed withdraws its stimulus, reserve managers need to consider the consequences this could have on the market.

These pandemic-related measures added to the inherent difficulties associated with managing MBS from outside the US, already a fragmented market in which states have different legislations that hamper comparisons between MBS pools. This makes it harder to establish a benchmark to assess performance and risk. Additionally, it is harder to model pre-payment risk, as pre-payments are not only dependent on macroeconomic factors.

“If you want to do it in-house, you really need an analyst working on all the mortgages, someone who knows how to analyse the market,” says the official at the Mediterranean central bank. “And you also need a system supporting this asset class – our platform is not able to manage this asset class.”

Because of these complexities, this central bank recently upgraded its MBS mandate with BNPP AM to $1.7 billion.

“BNP provides us not only with the tools to reap higher returns through MBS, but also regular meetings [during which] we obtain valuable, broader insights to [help] make decisions on our portfolio,” the official adds.

The Central Banking Awards were written by Christopher Jeffery, Daniel Hinge, Dan Hardie, Victor Mendez-Barreira, Ben Margulies and Riley Steward