LONDON, June 23 (Reuters) - Rising bond yields pose the biggest risk to financial markets, according to leading central banks, encouraging them to invest more of their record amounts of international reserves in equities, a survey showed on Monday.
But far from signaling an increase in risk appetite, this continued expansion into equities reflects a desire to diversify portfolios, generate returns and avoid losses on bond holdings if fixed income markets do start to sell off later this year.
The reserve managers surveyed were “generally bearish across most asset classes,” in the face of a potential rise in yields, and given that most assets have posted stellar gains over the past year, supported by waves of central bank liquidity.
The annual survey, conducted by Central Banking Publications last month and sponsored by HSBC, drew on responses from 69 central banks with a combined $6.7 trillion in reserves, some 57 percent of all reserves. The average holdings of the respondents was $97 billion.
Over half of the respondents, holding reserves worth $3.1 trillion, ranked rising yields as the most significant risk. Almost two thirds ranked it as either the most or second most significant.
“Given the impending normalisation of monetary policy among the developed economies, particularly in the U.S. and UK, reserve managers are very concerned about mark-to-market losses to be incurred by holding fixed income assets,” said one Asian reserve manager.
Rising bond yields and falling prices are worries for central banks, who usually put the lion’s share of their reserves in fixed income assets.
Almost 60 percent of respondents said the U.S. Federal Reserve’s policy of reducing its stimulus would affect how they manage their reserves. That could include diversifying portfolios away from emerging markets and into U.S. dollar-denominated assets and buying shorter-dated bonds instead of long-term assets.
Nineteen central banks invest in equities or might in the next five years, compared with 14 in last year’s survey. Only 11 respondents, or 16 percent, ruled out equities completely, saying their mandates didn’t allow it, stocks were too volatile or were only for central banks with “excess” reserves.
Although only a few of the central banks surveyed invest in exchange-traded funds (ETFs), “there is considerable latent support for them as an asset class,” the report said.
More than half the respondents, with $3 trillion of reserves, said they could envisage equities or ETFs being part of their portfolios.
That said, central banks were generally split down the middle on whether equities are a more attractive asset class now than they were a year ago.
The biggest shifts in positive sentiment were seen in A-rated government bonds and in deposits. Fifty-nine percent of the respondents said they are more attractive now than they were a year ago. Sixty-one percent of those surveyed said the same of deposits.
On the other hand, 84 percent said hedge funds are less attractive now than they were a year ago. Seventy-seven percent gave the same verdict on commodities and mortgage-backed securities.
The prospect of rising U.S. bond yields has greatly enhanced the appeal of the dollar, with 79 percent of respondents saying the dollar looks a more attractive currency now than it did a year ago.
Over 70 percent expressed the same sentiments towards sterling, for similar reasons. Two-thirds of respondents said the Chinese renminbi was more attractive because of the relative strength and growing influence of China’s economy.
“In a challenging global environment, the survey highlights a number of significant trends across the sector including continuing diversification of assets and currencies, and particularly a growing interest in investing in the renminbi,” said Christian Deseglise, global head of central banks and reserve managers at HSBC, the sponsors of the survey.
The prospect of further monetary easing by the euro zone, Japanese and Swiss central banks clouded the central banks’ view of the euro, yen and franc. Almost two-thirds said the euro was less attractive than it was a year ago. More than 80 percent said the same about the yen and franc.
The lending of central bank securities appears to be picking up, with around two-thirds of respondents saying they either lend out their assets or are considering it. (Created by Jamie McGeever; Editing by Larry King)