Core Focus: The distinction between passive and active management of reserve portfolios, the US passive management approach, and the European trend toward more active management.

In-Depth Notes:
The management style for reserve portfolios sits on a spectrum from passive to active. The choice reflects the central bank’s objectives, its resources, and its tolerance for active risk.

The US Passive Management Approach:
The Federal Reserve’s foreign reserves portfolios are passively managed, with purchases and sales conducted to meet an asset allocation target; the target is determined based on the portfolio’s broader goals of maximising return subject to the liquidity and safety objectives . The manager of the SOMA and the ESF foreign reserves portfolios consults regularly with the FOMC and the U.S. Treasury regarding the disposition of investments and the status of the reserves portfolios . Liquidity is the primary investment objective, and maintaining a high degree of safety is a secondary objective. Efforts to improve portfolio returns are considered only after the liquidity and safety objectives have been met . The SOMA and the ESF foreign currency reserves are managed so that their risk and return characteristics match as closely as possible. To the extent practical, investments are split proportionately between the SOMA and ESF holdings .

The ECB’s Active Management Framework:
In contrast, the ECB’s US dollar, Japanese yen, and Chinese renminbi reserves are actively managed by the ECB and selected NCBs. Active management means that portfolio managers take positions that deviate from the benchmark in order to generate excess returns (alpha). The framework is designed to create incentives to enhance performance and promote risk-taking at various levels, encourage open information and knowledge sharing, and support inclusiveness within the Eurosystem. The benchmarking framework is set at both strategic and tactical levels . Each NCB’s performance is measured against the tactical benchmark and against the other NCBs .

The European Trend Toward More Active Management:
The Eurosystem’s framework is designed to encourage active management. The Investment Committee determines the investment parameters, makes policy decisions, sets performance benchmarks, approves counterparties, sets permitted risk levels, and performs control and monitoring functions . The framework includes incentives for layers to actively use the risk budget. The incentive for the tactical benchmark level is the internal goal set by the Investment Committee, which sets a relative return target each year for each currency portfolio. The performance ranking among NCB portfolio managers is also an important incentive.

Performance Persistence and Style Differences:
Relative performance of NCBs appears to be persistent over time, with two groups of NCBs occupying relatively high or low positions. The difference in ranking between the best and bottom performers has been steadily increasing, reflecting differences in portfolio managers’ competences, portfolio management styles, and risk approaches. Some NCBs take medium-small positions with few changes over time, while other NCBs take relatively large positions and change them more often, demonstrating the diversification benefits of having several active portfolios with different styles.