Swiss National Bank's Investment Policy Reconsidered
Published in the Huffington Post United Kingdom.
The Swiss National Bank (SNB) President, Thomas Jordan must reconsider the SNB investment policy because its equity holdings have grown to around 71 billion Swiss francs in the third quarter of 2013.
Falling bond yields forces the SNB - like most market participants - to allocate more of their currency reserves to riskier assets like equities.
The question is not whether the SNB should establish a sovereign wealth fund in order to manage its currency reserves - the SNB declared that they did not want to go that path and we believe for good reason - but how can they improve their investment skills to manage the equity holdings in their balance sheet.
When Jordan spoke in November 2012 about SNB’s investment skills, which they have developed over the past 15 years, he failed to mention that the investment skills were developed when the SNB balance sheet was much smaller in absolute terms and consequently also its equity involvement which represented around 15 percent of the SNB currency reserves.
The new SNB investment policy should specifically target the responsibilities and investment tools of its investment committee in order to achieve cutting-edge investment skills know-how and better prepare the SNB for the challenges ahead.
The SNB balance sheet has surged to about 85 percent of the Swiss gross domestic product (GDP) because of the SNB decision in September 2011 - under the leadership of Philipp Hildebrand, the former head of the SNB - to set and defend the floor for the euro at CHF1.20.
To put the SNB balance sheet size in perspective, one has only to take a look at the Fed balance sheet, which is around 20 percent of US GDP, or at the ECB balance sheet, which is around 30 percent of GDP.
Unless Jordan can credibly show that the SNB will commit to a balance sheet which will represent a much smaller percentage of Swiss GDP in the near future, they will need to seriously reconsider how they will manage those equity assets going forward.
The SNB's monetary policy always has priority over the SNB's investment policy, which takes on a subordinated role.
Nevertheless has the explosion of the SNB balance sheet significantly increased the importance of the SNB investment policy.
Jordan emphasises that the main criteria they use to manage the SNB currency reserves are liquidity, security and return and that the importance of the criteria is exactly in that order.
As the saying goes 'last but not least,' the return has gained in importance because of the possible broad, serious consequences of potential losses.
The Current Internal SNB Investment Committee
When it comes to equity investments, the internal SNB investment committee practices a passive investment approach. One Chief Investment Officer leads the investment committee. The investment committee, a team of around 20 well-trained members, is responsible for implementing the investment strategy.
The portfolios are managed by both internal and external portfolio managers, with the majority managed internally. External managers are also used to benchmark the performance of the internal portfolio managers.
The New SNB Investment Committee
1) The new approach would replace the Chief Investment Officer role with a Chief Portfolio Allocator, who would allocate equity portfolios to Investment Committee members.
2) The new SNB Investment Committee members would invest the allocation of their currency reserves to equities in exchange-traded funds, equities or with external money managers.
3) The portfolio managers would combine the best of active and passive investing, which would break with the current SNB Investment Committee approach to managing equities entirely passively and avoid any stock-picking.
4) Since each of the members of the Investment Committee has their equity portfolio to manage, no one can hide behind the Investment Committee.
5) The performance of each Investment Committee member is reviewed and measured against the appropriate benchmarks on a monthly, quarterly, and yearly basis.
6) If a member of the Investment Committee falls behind the benchmark over a period of 2 to 3 years, then their membership has to be re-evaluated. Portfolio manager reviews can be performed at any time. The legitimacy of Investment Committee membership can be questioned if an inferior performance warrants it.
7) The equity portfolios of the Investment Committee portfolio managers should be managed within managed accounts, which would provide the SNB with the benefits of greater transparency and control.
Although such investment processes have been adopted in full or in part and have been implemented more or less successfully in the asset management industry, they have not been implemented in such a rigorous way at the SNB or any other central bank.
The benefits of the New SNB Investment Committee
1) Combining active and passive investing will increase the probability of outperforming an equity benchmark index.
2) Gathering valuable market intelligence.
3) Transferring know-how from the portfolio managers to the SNB.
4) Increasing the chance for future annual payouts to the 26 Swiss cantons.
5) Reporting the performance of the Investment Committee members' portfolios would help satisfy politicians and the Swiss people, who demand more accountability and transparency.
6) Only the best will apply and survive to the great benefit of the SNB and the Swiss people.
Enough reasons and benefits for Jordan and the SNB to reconsider the responsibilities of the SNB's Investment Committee.
„To improve is to change; to be perfect is to change often."
Winston Churchill (1874 - 1965)
THE BRAVE STEP Swiss National Bank's Investment Policy Reconsidered (PDF)