Core Focus: The practical strategies for constructing reserve portfolios, including the tranching framework, benchmark design, and the core-satellite approach to investment management.

In-Depth Notes:
The shift towards non-traditional assets has necessitated more sophisticated portfolio construction approaches. Reserve managers now use a range of strategies to balance the competing objectives of liquidity, safety, and return.

Tranching:
Central banks commonly divide their reserve portfolios into tranches, including working capital, liquidity and investment, with the investment tranche usually representing the largest share . The allocation to each tranche, which has its own currency allocation, benchmark and risk parameters, is guided by reserve adequacy metrics (e.g., import coverage and the ratio of short-term debt to reserves) . In countries that have limited reserves and greater short-term liquidity requirements, central banks are more likely to prioritise capital preservation and liquidity over maximising investment returns.

Benchmark Construction:
The design of the benchmark is critical for portfolio management. Global sovereign mandates focus exclusively on global government bonds. Global aggregate mandates include government, corporate, agency and securitised debt .

Several central banks have adopted creative benchmark strategies. The SDR currency basket is often used as a benchmark for currency allocation because of its neutral character as a representation of world economic activity . Botswana has adopted an approach that combines SDR-based currency allocation with an investment tranche (Pula Fund) that includes long-term bonds and equities . The Pula Fund fixed income currency benchmark replicates the SDR weights, while the Liquidity Portfolio invests in short-term bonds .

The Core-Satellite Approach:
Many reserve managers pursue a “core-satellite” approach: a large core in ultra-liquid safe assets (typically Treasuries and other advanced economy government bonds) plus a smaller satellite sleeve for yield and diversification . This approach allows reserve managers to maintain the safety and liquidity of the core portfolio while seeking enhanced returns from the satellite portfolio.

The Use of External Asset Managers:
Larger EM central banks often use external asset managers to broaden their exposure in non-traditional asset classes. These external managers provide thought leadership, technology transfer and specialised training . In Botswana, for example, external asset managers are used to enhance returns and gain skills in managing the Pula Fund . Similarly, India’s external reserves are managed partly by external asset managers .

Seizing Active Opportunities:
Seizing opportunities in the current market environment requires active portfolio management. This entails closely monitoring economic, financial and political risks (both domestic and geopolitical), managing duration with discipline, dynamically rotating across asset classes and tactically using derivatives . These measures are particularly important in a context where US policy remains a dominant driver of volatility, developed market government bonds and investment-grade credit can no longer be regarded as unquestioned safe havens, and correlations across traditional reserve assets have become increasingly unstable