Report on the Investment of Israel's Foreign Exchange Reserves in 2017

The annual report on the investment of Israel's foreign exchange reserves for 2017 was published today.[1] Following are the main points in the report:

 

• Israel's foreign exchange reserves totaled $113 billion at the end of 2017[2], an increase of $14.6 billion over the course of the year. The main factors in the increase were gains, income, price and exchange rate differentials (mark to market), which totaled a combined $7.5 billion, and Bank of Israel purchases of $6.6 billion within the framework of monetary policy.

 

• At the end of 2017, the level of reserves was slightly above the upper bound of the range of the appropriate level of reserves, of $70–110 billion, and was equivalent to 33 percent of GDP.

 

• In 2017, the holding rate of return on the reserves portfolio was 3 percent in numeraire terms, which is a basket of currencies—primarily comprised of the dollar and euro. This rate of return is the highest since 2009 and greater than the average return over the past three years of 1.7 percent.

 

• The rate of return was achieved in a financial environment of low yields to maturity, and even negative yields, on a considerable portion of bonds issued by major European countries, in which about one-third of the reserves are invested.

 

• The rate of return was achieved mainly as a result of a long term process, in which the share of reserves invested in risk assets—equities and corporate bonds—was gradually increased. This is within the framework of the risk level approved by the Monetary Committee.

 

• The contribution of active management—the investment’s actual deviation from the basic benchmark—was 273 basis points this year. Most of the contribution, 219 basis points, came from the investment in equities that benefited from the continued strong performance of equity markets in the investment countries. The rest of the contribution, 54 basis points, derived mainly from specific selection of duration and investment in spread assets, particularly in short term assets.

 

• The Monetary Committee decided to slightly increase the portfolio’s risk level, and the percentage of risk assets in the reserves portfolio continued to grow: the share of investment in equities increased to 13.3 percent, from 10.0 percent, and the share of investment in corporate bonds increased to 6.0 percent, from 4.8 percent. For most of the year, the share of investment in corporate bonds was 7.5 percent, and it was reduced toward the very end of the year.

 

• Market volatility was exceptionally low this year, against the background of excess liquidity resulting from central banks’ actions and the increasing global growth alongside low inflation. Therefore, the reserves portfolio’s level of volatility was lower than in the previous year, despite the increased share of risk assets, and was more worthwhile than in the past in terms of risk-adjusted yield.

 

• The Bank of Israel’s decision to invest part of the foreign exchange reserves in equities was taken with a long term view. The investment in equities more than doubled the cumulative return of the reserves portfolio in the past 6 years, but as equity markets are cyclical and volatile, it is reasonable to expect price declines in the future as well. (See the box on investment in equities in Chapter 4).

 

[1] The Hebrew version of the report was published today. The English version will be available within several weeks.

[2] The level of the reserves throughout the Report includes the International Monetary Fund’s allocations of SDRs and the balance of Israel’s reserve tranche in the IMF. At the end of 2017, their combined level was approximately $1.5 billion. For more on this issue, see “Bank of Israel Financial Statements for 2017” (forthcoming).