The Swiss national bank made a huge mistake: it didn’t reduce its portfolio risk in time, but remained exposed to stocks until capital gains evaporated and profit distributions are now compromised. This hedge fund style of investing is not responsible.
The Swiss National Bank (SNB) has once been described as a «big hedge fund». That goes back 12 years, when it started to massively buy euro and dollar assets in order to repress the Swiss franc. In the meantime, its investment portfolio went from 50 to 950 bn $ in less than a decade. Today, we are reminded of how relevant the hedge fund description is. The big exposure of the SNB portfolio to US tech companies has created an enormous leverage effect on its yearly results. Fantastic when the bubble was high, horrific when it burst.
The Nasdaq 100 is down 29% year-to-date. The other losing exposure of the SNB is to the euro, which lost 7% versus the Swiss franc between June and mid-August. Now the SNB is suffering unprecedented losses: they are estimated at 150 bn CHF by year end. In Q1 already, losses amounted to 33 bn CHF, and to 95 bn CHF after six months. Reserves for future distributions are now threatened. They amounted to 102 bn CHF for this year but will be wiped out, and no distribution will take place for 2022.
Still, let’s not forget that in addition to the 102 bn CHF in reserves, there are more than 100 bn CHF in accumulated profits over recent years: profits reached 49 bn CHF in 2019, 21 bn CHF in 2020 and 44 bn CHF in 2021. These were all unrealized gains, that are now turning into unrealized losses.
Woudn’t it have been better if some of those profits had been realized when there still was time, so that this money could have been put to good use, instead of remaining exposed to financial markets until it was too late? There is little doubt about that. Of course, converting massive amounts at once into Swiss franc would considerably lift its value, which is precisely what the SNB aims to avoid. But at least the SNB could have gradually reduced its exposure to the stock market in favor of bonds at the beginning of this year, thus de-risking its portfolio.
It could have realized small amounts systematically so as not to destabilize the foreign exchange market. Its mandate has never been to invest in foreign stocks for the love of it, and to sit on a big (unrealized) fortune that turned out to be a market time bomb. Especially now that the Swiss franc broke all-time records of strength against the euro this year.
At the end of 2021, when accumulated profits were at their highest, the national debate was that the Swiss people should benefit from this money. The question of distributing more of those profits to the Swiss Confederation and the Cantons gained prominence. The idea of creating a sovereign wealth fund was back on the table. Allocating part of this money to energy transition, or to supporting Swiss companies, or to the AHV (old-age and survivors insurance) was discussed.
But while we were debating and before any of those amounts could be allocated to anything socially or environmentally useful, the SNB money was left to evaporate in good part on the financial markets. Now there is no question of using those funds for the benefit of the population anymore.
If this exposure had been more cautiously managed, and part of it had been sold and put to good use, it would have been doubly clever, by converting some assets at the highest possible price while preventing the SNB losses.
Now all the wrong conclusions are being drawn from these losses. The SNB officials and some economists are using this unfortunate episode as confirmation that the central bank shouldn’t distribute more to the public or use those profits for any other purpose. They consider that the risk is too high, an irresponsible use of the money, because reserves are melting.
One might answer: why are those reserves melting and whose fault is it? What about this irresponsible exposure to the tech market bubble and to the euro, whose risk wasn’t properly managed? Isn’t that a case of using money irresponsibly?
The legal argument had also been used over the course of the years to prevent any use of this money (when it was abundant) outside of the strict missions of the SNB. But what do the Constitution and the law say about the use of the SNB money? According to al. 2 of the Swiss Constitution’s article related to the SNB, it conducts a monetary policy that «serves the general interests of the country». Is that not clear? True, the independence of the SNB must be preserved at all times. And the Confederation mustn’t intervene in matters of monetary policy.
But allocating profits according to more socially and environmentally responsible principles would certainly not infringe on this principle. Al. 3 says that the SNB must keep enough reserves. This condition is no longer met this year. But it was largely met in the previous years, when the reserves were way beyond legal requirements. It is the persistence of the risky exposure this year that put an end to this condition.
The law says that «at least» two thirds of the net profit has to go to the Cantons, and one third to the Confederation. «At least» means it can be more. Every year, 2 to 4 bn CHF have been distributed by the SNB to the Confederation and Cantons, but in 2021, because of its surging profits, the SNB concluded a new convention with the government, whereby maximum distribution could reach 6 bn CHF until 2025, provided the profit on the balance sheet was higher than 40 bn CHF. The gradual increase of the distributions over the years strongly contrasts with the quickness of market reversals, which would have required much more anticipation and a more systematic asset sales policy.
Well before the market reversal, the opponents had argued that excess distributions would weaken the quality of the SNB balance sheet over time. Is it the distribution or the market exposure that is weakening the quality of the balance sheet?
In conclusion, the losses of the SNB shouldn’t be used by the bank to defend its independence and to claim that it would be irresponsible to distribute more money to the public or to create a sovereign wealth fund. These losses are, rather, an argument against its extremely risky investment policy, its permanent exposure to volatile markets. Irresponsibility lies in not managing those risks adequately and remaining invested in overvalued stocks, instead of reducing its exposure and realizing gradually and cautiously some gains in order to serve the public interest and give back this cash to those it is accountable to.