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CONTRIBUTORS

Robert O. Abad

Product Specialist
Western Asset

EM and frontier market central banks have shifted from a narrow focus on holding US dollars and USTs as a crisis buffer to a more diversified, strategically managed approach to reserves. This evolution, driven by financial crises, commodity swings, and geopolitical tensions, has expanded portfolios into higher-yielding and non-traditional assets such as investment-grade corporates, mortgage-backed securities, and green bonds. Regional strategies vary: Latin America emphasizes risk management and gradual diversification, the Middle East leans on gold alongside traditional USD assets, Asia leads on innovation and frontier markets are cautiously expanding asset pools that include RMB holdings. Despite these changes, maintaining ample reserves in safe, liquid assets remains a priority, especially amid rising fiscal risks and policy uncertainty in DM economies.

Key takeaways:

  • In Latin America, reserve portfolios are expanding to include US agency debt, equities, and investment-grade corporate bonds, primarily through ETFs.
  • In the Middle East, global aggregate strategies remain the dominant approach for central banks seeking credit exposure, balancing the pursuit of incremental returns with traditional liquidity priorities.
  • Asian central banks lead the world in reserve management sophistication, using advanced liquidity operations and derivatives to protect headline reserves while maintaining flexibility.
  • The growth of Chinese RMB swap lines and modest RMB allocations across several regional central banks reflects deepening trade ties with China and cautious currency diversification, particularly in frontier markets.
  • Rising fiscal and monetary pressures in DM economies, especially the US, are prompting EM central banks to reassess heavy concentration in US dollar assets.
  • EM central banks now have an opportunity to exploit valuation dislocations in DM government debt while also exploring short-duration, low-volatility instruments that combine liquidity with income generation.

WHAT ARE THE RISKS?

All investments involve risks, including possible loss of principal. Past performance is no guarantee of future results.  Please note that an investor cannot invest directly in an index. Unmanaged index returns do not reflect any fees, expenses or sales charges.

Equity securities are subject to price fluctuation and possible loss of principal.

Fixed-income securities involve interest rate, credit, inflation and reinvestment risks; and possible loss of principal. As interest rates rise, the value of fixed income securities falls. Low-rated, high-yield bonds are subject to greater price volatility, illiquidity and possibility of default.

Municipal income may be subject to state and local taxes. Some income may be subject to the federal alternative minimum tax for certain investors. Capital gains, if any, are taxable.

Changes in the credit rating of a bond, or in the credit rating or financial strength of a bond’s issuer, insurer or guarantor, may affect the bond’s value.

US Treasuries are direct debt obligations issued and backed by the “full faith and credit” of the US government. The US government guarantees the principal and interest payments on US Treasuries when the securities are held to maturity. Unlike US Treasuries, debt securities issued by the federal agencies and instrumentalities and related investments may or may not be backed by the full faith and credit of the US government. Even when the US government guarantees principal and interest payments on securities, this guarantee does not apply to losses resulting from declines in the market value of these securities.

International investments are subject to special risks, including currency fluctuations and social, economic and political uncertainties, which could increase volatility. These risks are magnified in emerging markets. Investments in companies in a specific country or region may experience greater volatility than those that are more broadly diversified geographically. The government’s participation in the economy is still high and, therefore, investments in China will be subject to larger regulatory risk levels compared to many other countries. There are special risks associated with investments in China, Hong Kong and Taiwan, including less liquidity, expropriation, confiscatory taxation, international trade tensions, nationalization, and exchange control regulations and rapid inflation, all of which can negatively impact the fund. Investments in Taiwan could be adversely affected by its political and economic relationship with China.

WF: 7035509