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Beware central banks’ share-buying sprees; Revenue raising could ‘contribute to overheated asset prices’

Last updated: June 19, 2014 5:55 pm

Beware central banks’ share-buying sprees

By Ralph AtkinsAuthor alerts

Revenue raising could ‘contribute to overheated asset prices’

Like the rest of us, the world’s central bankers have had to cope since 2008 with low interest rates wiping out returns on their investments. They may attract little sympathy – who was it who slashed rates? But the consequences matter for markets, especially if central banks follow their own injunctions and move into riskier assets, notably equities.

An eye-catching report this week said that “a cluster of central banking investors has become major players on world equity markets”. An important driver was revenues foregone on bond portfolios.

Put together by the Official Monetary and Financial Institutions Forum, which brings together secretive and normally conservative central bankers, the report’s conclusions have authority. Some equity buying was in central banks’ capacity as, in effect, sovereign wealth fund managers. China’s State Administration of Foreign Exchange, which has $3.9tn under management, has become the world’s largest public sector holder of equities.

The boundary, however, with monetary policy making is not always clear. According to the Omfif report, China’s central bank itself “has been buying minority equity stakes in important European companies”.

Conflicts of interest

The irony of central bankers joining the global “hunt for yield” is delicious. Yet a big switch into equities is potentially problematic. With world stock markets hitting all-time highs, are central banks buying at the top and encouraging others to follow? Will they face conflicts of interest as they seek to pull economies out of their post-2007 sluggishness, with their responsibilities muddied – and their effectiveness lowered as a result?

Another worry is of sharp market corrections triggered by central banks’ actions or rumours about possible actions; transparency is not a strong point.

Central bank purchases of shares are not new. The Dutch central bank has invested in equities for decades. The benchmark for its €1.4bn portfolio is the MSCI global developed markets index.

The Italian, Swiss and Danish central banks also own equities. Across Europe, central banks face pressures from cash-strapped governments to boost income. As presumably cautious and wise investors, they have also been put in charge of managing sovereign wealth funds – Norway’s, for instance.

In Asia, the Hong Kong Monetary Authority launched a large-scale stock market intervention in 1998, splashing out about $15bn – and ended up making a profit. Since the Asian financial crisis of that year, official reserves have expanded massively – far beyond what might be needed in future financial crises or justified by trade flows.

While such cushions may provide stability, their management is harder when interest rates are at historic lows and liable to rise. “Blowing it is actually quite easy,” joked Julia Leung, a former HKMA official, at this week’s London launch of the Omfif report. For reserve managers invested in fixed income, she warned, “it will be a very bad year”.

Tweak turmoil

When central bank reserves’ managers tweak strategies, the effects are massive. Since 2000, emerging and developing economies’ foreign exchange holdings have expanded from about $700bn to almost $8tn, according to International Monetary Fund data. The switch of at least some of that into euros – to diversify portfolios or for geostrategic reasons – goes a long way towards explaining the recent strength of Europe’s single currency.

Equity investing entails risks for central banks not just because share selection involves favouring particular companies or economies. Equities are also more volatile than government bonds. Big losses could lead to a political backlash, undermining central banks’ credibility and political independence. Little wonder, they are reluctant to divulge details about what they are doing.

Currently, however, the problem might be the opposite: of sending a signal that equities are safe. Central banks’ move into equities “could potentially contribute to overheated asset prices”, Omfif warns.

What is the answer? Greater accountability and transparency are obvious solutions – if contrary to central bankers’ instincts. It needs to be clear when central banks are implementing monetary policy or acting as sovereign wealth fund managers.

Surplus assets accumulated by central banks in pursuit of monetary policies should “be handed over to their shareholder, the government, to be invested by separate agencies with their own legal framework”, argues Julian Callow, an economic consultant and central bank watcher.

Some of that is being done, but there is still reason to worry just how omni-competent central bankers really are.

 

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About bambooinnovator
KB Kee is the Managing Editor of the Moat Report Asia (www.moatreport.com), a research service focused exclusively on highlighting undervalued wide-moat businesses in Asia; subscribers from North America, Europe, the Oceania and Asia include professional value investors with over $20 billion in asset under management in equities, some of the world’s biggest secretive global hedge fund giants, and savvy private individual investors who are lifelong learners in the art of value investing. KB has been rooted in the principles of value investing for over a decade as an analyst in Asian capital markets. He was head of research and fund manager at a Singapore-based value investment firm. As a member of the investment committee, he helped the firm’s Asia-focused equity funds significantly outperform the benchmark index. He was previously the portfolio manager for Asia-Pacific equities at Korea’s largest mutual fund company. KB has trained CEOs, entrepreneurs, CFOs, management executives in business strategy, value investing, macroeconomic and industry trends, and detecting accounting frauds in Singapore, HK and China. KB was a faculty (accounting) at SMU teaching accounting courses. KB is currently the Chief Investment Officer at an ASX-listed investment holdings company since September 2015, helping to manage the listed Asian equities investments in the Hidden Champions Fund. Disclaimer: This article is for discussion purposes only and does not constitute an offer, recommendation or solicitation to buy or sell any investments, securities, futures or options. All articles in the website reflect the personal opinions of the writer.

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