Main points
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The financial environment |
The financial environment was exceptional in the reviewed year. The sharp increase in inflation led central banks to adopt restrictive monetary policy and to raise interest rates aggressively, after many years in which rates were very low. The rapid increase in interest rates from low levels led to sharp declines in stock prices, to high volatility in markets, and to steep increases in yields to maturity on government bonds. As a result of these developments, all types of financial asset classes in advanced economies, except for very short term US government bonds, had negative returns. This phenomenon is very anomalous in financial markets as, for the most part, there is a negative correlation between equities and government bond returns, which provides natural hedging of the portfolio. In addition, the rapid pace of interest rate increases by the US Federal Reserve, compared to other major central banks, and the increase in risk aversion in financial markets, led to marked strengthening of the dollar vis-à-vis most major currencies. |
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Return on the portfolio in terms of the currency benchmark |
The negative developments in financial markets worldwide were reflected in the returns on the foreign exchange reserves portfolio: the rate of return on the foreign exchange reserves portfolio in 2022, in terms of the currency benchmark, was negative, at -5.7 percent. Over a longer term perspective, the reserves portfolio had a positive average annual rate of return of 0.3 percent over the past 3 years and 1.4 percent over the past 5 years (Table 1a). TABLE 1a Rate of return on the foreign exchange reserves portfolio, annual and average multiyear perspectives, in terms of the currency benchmark, percent, annual terms
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Return on the portfolio in shekel terms |
In view of the weakening of the shekel, the rate of return on the foreign exchange reserves portfolio was positive in shekel terms, at 3.4 percent. Table 1b Rate of return on the foreign exchange reserves portfolio, annual and average multiyear perspectives, in terms of the shekel, percent, annual terms
A negative sign in the change of the exchange rate indicates appreciation of the shekel. |
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Level of the reserves and sources of the change in the reserves |
The losses in the foreign currency reserves portfolio, and the worldwide appreciation of the dollar, led to a decline in the level of the foreign currency reserves, which were $194.2 billion at end 2022. The decline in the level of the reserves stemmed mainly from a loss of $11.8 billion due to the decline in equities and bond prices and from exchange rate losses in the amount of $6.3 billion, due to the weakening against the dollar of the currencies in which the reserves are invested. It is important to stress that the majority of central banks recorded declines in their reserves in view of the negative developments in the global financial markets. |
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Update of the currency benchmark |
In the beginning of 2022, the currency benchmark, which serves as the measurement currency of the foreign exchange reserves’ rate of return, was updated. The benchmark was updated with the goal of achieving a shekel rate of return that will cover the cost of holding the reserves over the long term by minimizing the volatility of the reserves’ yield in shekel terms, which derives from the volatility in the exchange rates of the investment currencies vis-à-vis the shekel. This is done by expanding the currency diversification of the reserves among the currencies recognized as reserve currencies in countries with broad and liquid asset markets. The updated currency benchmark includes seven major reserve currencies, with the following weights: 61 percent US dollar, 20 percent euro, 5 percent pound sterling, 5 percent Japanese yen, 3.5 percent Australian dollar, 3.5 percent Canadian dollar, and 2 percent Chinese yuan. |
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Composition of assets in the reserves |
As part of the asset allocation for 2022, the share of risk assets in the foreign exchange reserves portfolio was increased moderately. The increase in the share of risk assets is part of the gradual strategic process to increase the portfolio’s return in the medium term, while taking into account that in the short term there could be an increase of its volatility and there could even be losses. In view of the moderate growth in the share of risk assets and in view of the portfolio being adjusted gradually during the course of the year, the impact of the process on the portfolio’s return was marginal. |
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Contribution of the excess return in currency benchmark terms |
This year, the contribution of the excess return, measured by comparing the portfolio return with the risk-free portfolio (the basic benchmark) return, was negative at -5.9 percent. The main source of this negative contribution was investment in equities (-3.0 percent) and the duration of the government bond portfolio (-2.9 percent), with an average duration of approximately 24.7 months, compared to the duration of the basic benchmark, which was six months. |
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Risk level of the reserves portfolio |
The portfolio’s risk level, which is affected by the share of the risk assets in the portfolio as well as the volatility in the financial markets, rose this year, but did not exceed the maximum risk level defined in the investment policy guidelines.
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