Market movements over the past year have been very volatile across several asset classes. This has presented a challenge to central banks, particularly those that have diversified their foreign exchange investments into new assets such as credit instruments and equities. In order to ensure that investment positions are properly balanced, it is crucial to be able to more accurately assess the actual risks, returns and diversification tradeoffs associated with portfolio positions using credible stress scenarios versus custom benchmarks.
This is where Aladdin Risk, the risk management engine developed by $10 trillion wealth management firm BlackRock, offers an advantage. Not only does the system provide day-to-day visibility into portfolio positions and exposures, performance and attribution, portfolio risk, scenario analysis, compliance and oversight, but it helps institutions – of all types – to rethink and redefine portfolio management. Whether its clients want to gain a better understanding of their underlying risks, asset allocations or green portfolio construction, the platform provides an accurate feed for timely reporting of positions – both internally and externally managed – for most asset classes and instrument types, inclusive Derivatives, Structured Products and Exchange Traded Funds.
For a year now, the service has also included information on private assets such as real estate, private equity and infrastructure. While most central banks are not active investors in private wealth, many sovereign wealth funds invest in such areas.
All of this is designed to give investors the data and transparency to make their own decisions about various metrics, including duration, convexity, value-at-risk, credit risk measures and credible stress tests. Central banks can choose the best single or combination of metrics for each use case. For example, one institution recently implemented VAR – which provides an alternative measure to credit spreads – to determine expected credit loss by estimating default probabilities and recovery rates and provides a clear overview of a rating transition matrix.
Another benefit of the Aladdin system for reserve managers is the ability to create custom benchmarks – measured by performance. Aladdin not only allows customization of the types of assets referenced, but also the currency benchmark – and BlackRock configured the platform specifically for one central bank client, the Bank of Israel.
The Central Bank of Israel – which started using Aladdin in 2019 and now manages $208 billion fx Assets (including reserves purchased as part of its natural gas purchase program) – sets its currency reference, a basket of currencies used alongside the shekel to measure the return on its foreign exchange reserves. As a return on the fx Reserves are also measured against the currency benchmark, their composition is defined as a risk-free currency composition for the reserve portfolio manager. She then ensures that her investment exposures are aligned with the basket from then on fx exposure perspective.
“They have a sophisticated, hybrid benchmark structure that required some system adjustments to ensure we could properly support them,” says Oded Levin, director in the Aladdin Analytics and Quantitative Solutions team at BlackRock.
Another major win for the Bank of Israel from Aladdin was that it previously did not have a single and consistent view of risk and return across internally and externally managed assets. The introduction of Aladdin made sure of that.
“A portion of our portfolio, which includes equities, corporate bonds and mortgage-backed securities, is managed externally by various outside managers,” said Roee Levy, senior analyst in the risk management unit of the Bank of Israel’s markets department.
“In Aladdin, in addition to internal portfolio positions, we can also view our holdings with each external manager on a daily basis, allowing us to analyze our internal and external investments more holistically.”
Other important benefits for reserve managers relate to environmental, social and governance (IT G) considerations – as well as climate modeling tools related to securities. examination IT G factors is becoming an increasingly important task for central bankers who invest taxpayers’ money. Aladdin’s platforming capabilities allow reserve managers to analyze their positions from more than just one side IT G perspective, but also the evaluate IT G Effects of portfolio changes.
This IT G A turnkey solution can also make deployment easier IT G Information external to meet evolving demands for transparency. “Central banks will likely need to provide more transparency on how the portfolio is viewed from the start IT G point of view,” says Yitzi Stern, Managing Director at BlackRock Solutions.
Ultimately, Aladdin Risk is a huge risk technology engine that also offers stress testing capabilities that provide useful insights into portfolio behavior under macroeconomic circumstances or changes in market context, such as. B. increased or decreased volatility. This ability to stress different scenarios in which covariance matrices or individual factors are shocked can help reserve managers gain clearer insights into portfolio impacts, based on Aladdin and/or their own data.
This feature can be used as part of a regular asset allocation process to analyze the sensitivities of strategic portfolios to different scenarios and potential events – to better understand overall resilience.
The stress tests and scenario analysis can also be used to analyze the risk to the portfolio from new events that cause increased volatility. The Bank of Israel is currently investigating this in connection with the ongoing crisis between Russia and Ukraine.
“For this analysis, we used long-term correlations according to our standard long-term model, which we use regularly. In addition, we also examined the outcomes of the different scenarios using short-term correlations based on the pressure period around 2014 when Russia invaded Crimea,” explains Roee.
“Undoubtedly, using Aladdin was an important step in improving and advancing our risk management,” said Roee of the Bank of Israel. “Even today, two years after implementing this tool, we are still learning how to better use it and leverage its capabilities for our risk management needs.”
The Central Banking Awards were written by Christopher Jeffery, Daniel Hinge, Dan Hardie, Victor Mendez-Barreira, Ben Margulies and Riley Steward