Enhancing the Toolbox of Fixed Income Active Portfolio Management

Many central banks adopt an active investment style for reserve management. This paper discusses various possible enhancements to active management tools and processes to generate extra returns in an increasingly challenging environment. The proposed framework is based on an affine model, which includes macroeconomic and market sentiment indicators among the explanatory variables. Using estimates of expected excess returns drawn from the model, an operational indicator produces input highlighting the portfolio's exposure to duration risk. This indicator is incorporated within a broader framework, in which a scorecard considers a range of qualitative elements, including consensus figures on macroeconomic data, monetary policy and interest rates. These elements are then combined with the model output to produce a comprehensive indication with respect to portfolio deviation from the benchmark. It should be noted that the approach presented in this paper is experimental; it has not yet been used in an active portfolio. Finally, consideration is given to the governance of the central bank investment process in order to assess how the proposed enhancements could strengthen the decision-making process. The analysis suggests that the scorecard with model-based input may address some weaknesses inherent in tactical decision-making