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The annual report on the investment of Israel's foreign exchange reserves for 2012 was published today, the following are the main points in the report:
  •   Israel's foreign exchange reserves increased by about $1 billion in 2012, compared with an increase of about $4 billion in the previous year, and at the end of 2012 they totaled $75.9 billion.[1] In 2012, the Bank of Israel did not intervene in the foreign currency market, after continuous interventions from March 2008 through July 2011.
  •   This year, the holding period rate of return on the reserves, in terms of the numeraire[2], was 1.59 percent, compared with 1.18 percent in the previous year and around 2.95 percent, on average, between 2003 and 2012. As in 2011, this return was affected to a large extent by the low level of interest rates and yields to maturity in financial markets, and by continued management of the reserves with a shorter duration than in previous years. 
  •   The active management contribution in 2012 was 117 basis points, more than 3 times the average of the past decade. Half of the contribution was derived from the asset management of the portfolios of currencies included in the numeraire (Dollar, Euro and British Pound)—primarily the investment in spread assets, which are not included in the benchmark and which yielded excess return over the benchmark assets, as the spreads narrowed during the year. The other half of the contribution derived primarily from the investment of part of the reserves in countries whose currencies and assets are not included in the numeraire and the benchmark. This contribution was composed of exchange rate differentials in favor of these currencies, relative to currencies included in the numeraire and by outperformance of the assets in those countries relative to the benchmark assets.
  •  In 2012, the ratios between the reserves and various aggregates in the market which are customarily used as the basis for assessing the adequacy of the level of the reserves remained high. However, they did not approach the upper bound of the distribution of these ratios in other countries. The high level of these ratios strengthens the resilience of the economy in the face of crises, and improves Israel's international financial standing.
  • The background conditions to the management of the reserves in 2012 continued to be complex and volatile. In the first half of the year, the deterioration of the crisis in Europe increased concern of the euro bloc breaking apart—a major risk to the global economy. In the second half, this risk declined markedly due to aid programs and to statements by the president of the ECB which contributed to some calming of the markets, while macro data in Europe and around the world remained weak. In the US, positive macro data throughout the year indicated a slow and moderate recovery, while towards the end of the year, the problems related to the "fiscal cliff" and the debt ceiling contributed to an increase in uncertainty in the markets.
  •   The debt crisis in Europe led to an increase in credit risk during the year, primarily in eurozone countries, as well as worldwide, bringing with it ratings downgrades by credit rating agencies. Accordingly, the Bank of Israel continued to reduce the exposure of the reserves to countries for which the macro situation deteriorated.
  •  The yields to maturity on government bonds, in countries in which most of the foreign exchange reserves are invested, remained at low levels during the year, and some even declined to negative levels. Thus, the main risk to the reserves portfolio remained interest rate risk. The duration of the foreign exchange reserves remained short, in order to minimize the capital losses in the event of an increase in yields to maturity.
  •  Concern over the realization of interest rate risk was at the basis of the Bank of Israel's decision to invest this year, for the first time, about 3 percent of the foreign exchange reserves in the US stock market; this was in order to improve the risk-return ratio of the reserves.
  •  During the course of the year, the diversification of the investment of the foreign exchange reserves, which began in the middle of 2010, continued and was even expanded to currencies and assets of several advanced economy countries with relatively strong economic foundations and whose currencies are not included in the numeraire and the benchmark. During 2012, the extent of the average exposure to those countries was 9.7 percent, similar to the previous year.

[1] The level of the reserves includes allocations of Special Drawing Rights by the International Monetary Fund to member countries (SDR Allocation) and Israel's balance of the Reserve Tranche of the Fund. At the end of 2012 these reached $1.8 billion, similar to the level at the end of 2011. For more on this issue, see the Bank of Israel's Financial Statements for 2012.
[2] The numeraire is a currency basket in which the foreign exchange reserves are measured. The numeraire serves as the neutral currency composition of the reserves.