Advances in the Practice of Public

Investment Management Narayan

Bulusu
Visit to download the full and correct content document:
https://textbookfull.com/product/advances-in-the-practice-of-public-investment-manag
ement-narayan-bulusu/
More products digital (pdf, epub, mobi) instant
download maybe you interests ...

Surgical and Perioperative Management of Patients with

Anatomic Anomalies Deepak Narayan (Editor)

https://textbookfull.com/product/surgical-and-perioperative-
management-of-patients-with-anatomic-anomalies-deepak-narayan-
editor/

Public Management Theory and Practice 1st Edition

Konrad Raczkowski (Auth.)

https://textbookfull.com/product/public-management-theory-and-
practice-1st-edition-konrad-raczkowski-auth/

The foundations of international investment law

bringing theory into practice Douglas

https://textbookfull.com/product/the-foundations-of-
international-investment-law-bringing-theory-into-practice-
douglas/

Public Services in EU Trade and Investment Agreements

Luigi F. Pedreschi

https://textbookfull.com/product/public-services-in-eu-trade-and-
investment-agreements-luigi-f-pedreschi/
Foundations of Investment Management Mastering
Financial Markets Asset Classes and Investment
Strategies David E Linton

https://textbookfull.com/product/foundations-of-investment-
management-mastering-financial-markets-asset-classes-and-
investment-strategies-david-e-linton/

Public Policy and Performance Management in Democratic

Systems: Theory and Practice 1st Edition Shlomo Mizrahi
(Auth.)

https://textbookfull.com/product/public-policy-and-performance-
management-in-democratic-systems-theory-and-practice-1st-edition-
shlomo-mizrahi-auth/

Public Administration Understanding Management Politics

and Law in the Public Sector David H. Rosenbloom

https://textbookfull.com/product/public-administration-
understanding-management-politics-and-law-in-the-public-sector-
david-h-rosenbloom/

Public relations the profession and the practice

Lattimore

https://textbookfull.com/product/public-relations-the-profession-
and-the-practice-lattimore/

The Palgrave Handbook of Public Administration and

Management in Europe 1st Edition Edoardo Ongaro

https://textbookfull.com/product/the-palgrave-handbook-of-public-
administration-and-management-in-europe-1st-edition-edoardo-
ongaro/
Edited by Narayan Bulusu, Joachim Coche, Alejandro Reveiz, Francisco Rivadeneyra,Vahe Sahakyan, Ghislain Yanou
Advances in the Practice of Public Investment
Management
 Narayan Bulusu • Joachim Coche
Alejandro Reveiz • Francisco Rivadeneyra
Vahe Sahakyan • Ghislain Yanou
Editors

Advances in the
Practice of Public
Investment
Management
Portfolio Modelling, Performance Attribution
and Governance
Editors
Narayan Bulusu Joachim Coche
Bank of Canada Bank for International Settlements (BIS)
Ottawa, ON, Canada Basel, Switzerland

Alejandro Reveiz Francisco Rivadeneyra

Finance Department Bank of Canada
Inter-American Development Bank Ottawa, ON, Canada
Washington, DC, USA
Ghislain Yanou
Vahe Sahakyan World Bank
Bank for International Settlements (BIS) Washington, DC, USA
Basel, Switzerland

ISBN 978-3-319-90244-9    ISBN 978-3-319-90245-6 (eBook)

https://doi.org/10.1007/978-3-319-90245-6

Library of Congress Control Number: 2018942901

© The Editor(s) (if applicable) and The Author(s) 2018

This work is subject to copyright. All rights are solely and exclusively licensed by the
Publisher, whether the whole or part of the material is concerned, specifically the rights of
translation, reprinting, reuse of illustrations, recitation, broadcasting, reproduction on
microfilms or in any other physical way, and transmission or information storage and retrieval,
electronic adaptation, computer software, or by similar or dissimilar methodology now
known or hereafter developed.
The use of general descriptive names, registered names, trademarks, service marks, etc. in this
publication does not imply, even in the absence of a specific statement, that such names are
exempt from the relevant protective laws and regulations and therefore free for general use.
The publisher, the authors and the editors are safe to assume that the advice and information
in this book are believed to be true and accurate at the date of publication. Neither the
publisher nor the authors or the editors give a warranty, express or implied, with respect to
the material contained herein or for any errors or omissions that may have been made. The
publisher remains neutral with regard to jurisdictional claims in published maps and
institutional affiliations.

Cover illustration: Andrew Paterson / Alamy Stock Photo

Printed on acid-free paper

This Palgrave Macmillan imprint is published by the registered company Springer Nature
Switzerland AG
The registered company address is: Gewerbestrasse 11, 6330 Cham, Switzerland
 Preface

The great financial crisis has left a large imprint on investment manage-
ment. The combination of (1) a fragile recovery in the major economies
and its spillover effects on global growth, (2) increased pressures on estab-
lished patterns of global trade, and (3) uncertainty about the effect of an
eventual unwinding of accommodative monetary policies intended to pro-
vide support to the financial system has created new challenges for invest-
ment managers, from divergent policy responses across countries to shifts
in the joint dynamics of asset prices across geographies. In this environ-
ment, asset managers are challenging their commonly-accepted invest-
ment paradigms.
In particular, public investment managers are navigating the challenges
posed while taking into account their unique investment rationales, risk
preferences, and governance structures. For example, public investors
have been called upon to re-evaluate their investment universe and the
benefits of active trading strategies to be able to achieve the returns that
would help meet their obligations. Further, they are also rethinking their
governance structures as well as their human and technical resources to
keep pace with changing management practices.
This book covers some of the latest advances in the practice of public
investment management, which were presented at the 6th Public Investors
Conference, jointly organised by the Bank for International Settlements,
the World Bank, and the Bank of Canada. The papers presented in this
edition of the premier biennial conference for public investment manage-
ment, hosted at the headquarters of the World Bank in Washington, DC,

v
vi PREFACE

contain some of the most up-to-date developments in the research and

implementation of public asset management.
This book is relevant to four categories of readers: (1) practitioners of
public investment management, (2) investment consultants advising pub-
lic managers, (3) academics/researchers, and (4) regulatory and oversight
bodies of public investors. By familiarising readers with both the state-of-­
the-art research dealing with, and policies adopted by, public investors,
this book aims to provide the context to current public investment
practice.
The book is organised into four parts, each covering one of the four
major topics of interest to public investment managers. In part one, four
chapters deal with the implementation, performance, and governance of
foreign reserves. The first two chapters address fundamental questions of
whether (and how) foreign reserves should be managed to hedge liabilities
and whether a mix of active or passive investing is optimal. This is a peren-
nial question for foreign reserves and sovereign wealth funds alike. The
next two chapters deal with the governance of public investors, including
a unique measure to help benchmark fund managers’ performance.
The second part of the book proposes quantitative tools to tackle
uncertainty in the interest-rate and credit-risk environment. The first two
chapters propose frameworks to actively manage sovereign bond portfo-
lios of (1) one country using macro variables for predicting zero-coupon
yield curves and (2) multiple countries based on their exposure to interest-­
rate differentials across countries. The next two chapters analyse the short-­
term and long-term drivers of credit risk.
Part three discusses portfolio construction paradigms. The first chapter
shows a method to conditionally optimise portfolios based on the prevail-
ing macroeconomic regime. The next two chapters discuss the relative
merits of the well-established paradigms of benchmark-relative, absolute-­
return, factor-based, and industry-based portfolio construction.
The final part of the book dives deeper, emphasising the dynamics of
the major asset classes in which public investors have a significant pres-
ence. Two chapters demonstrate the effect of benchmark investors and
investor clienteles on asset flows and prices, and a third analyses sources of
possible diversification in asset markets that are increasingly correlated.
Taken together, we believe that the advances in the practice and theory
of public investment management highlighted in this volume could not
just serve as a reference to readers but could also prove to be a launchpad
for future advances in the field.
 PREFACE
   vii

This book would not have been possible without the contribution of,
first and foremost, the presenters at the 6th Public Investors Conference.
We are grateful for their permission to publish their original work in this
volume. The editors wish to acknowledge the hospitality of the World
Bank and the funding provided by the Bank for International Settlements,
the World Bank, and the Bank of Canada, for making the conference pos-
sible. We thank Shengting Pan and María Margarita Sánchez, of the
World Bank, for their unflinching support in organising the conference.
We also thank the many participants and referees from multiple institu-
tions, whose insightful comments greatly benefitted the authors and edi-
tors in preparing the chapters included in this book: Reena Aggarwal,
Laura Alfaro, Jacob Bjorheim, Pierre Cardon, Ludwig Chincarini, Aimee
Dibbens, Kevin Dunn, John Gandolfo, Scott Hendry, Jianjian Jin, Sylvain
Leduc, Jorge Cruz López, Philippe Muller, Ruth Noble, Ken Nyholm,
Arunma Oteh, Tommaso Perez, and Oreste Tristani. Finally, we are
indebted to Tula Weiss, our Editor at Palgrave Macmillan, whose perse-
verance, negotiation abilities, and sage advice were essential to the publi-
cation of this book.

Ottawa, ON, Canada Narayan Bulusu

Basel, Switzerland  Joachim Coche
Washington, DC  Alejandro Reveiz
Ottawa, ON, Canada  Francisco Rivadeneyra
Basel, Switzerland  Vahe Sahakyan
Washington, DC  Ghislain Yanou
 Contents

Part I Foreign Reserves Management Strategies:

Implementation, Performance and Governance   1

1 Hedging Potential Liabilities of Foreign Reserves

Through Asset Allocation   3
Daniel E. Diaz, Julián David García-Pulgarín, Cristian Porras,
and Marco Ruíz

2 Setting the Appropriate Mix Between Active and Passive

Management in the Investment Tranche of a Foreign
Reserves Portfolio  27
Daniel Vela Barón

3 A New Fixed-Income Fund Performance Attribution

Model: An Application to ECB Reserve Management  45
Francesco Potente and Antonio Scalia

4 Sovereign Wealth Fund Investment Performance,

Strategic Asset Allocation, and Funding Withdrawal Rules  73
Michael G. Papaioannou and Bayasgalan Rentsendorj

ix
x CONTENTS

Part II Asset Allocation and Interest Rate & Credit Risk

Environment 101

5 A Macro-Based Process for Actively Managing Sovereign

Bond Exposures 103
Jacob Bjorheim, Joachim Coche, Alex Joia, and Vahe
Sahakyan

6 Carry On? 131
Joachim Coche, Mark Knezevic, and Vahe Sahakyan

7 Short-Term Drivers of Sovereign CDS Spreads 161

Marcelo Yoshio Takami

8 Long-Term Expected Credit Spreads and Excess Returns 215

Erik Hennink

Part III Portfolio Construction 245

9 Regime Identification for Sovereign Bond Portfolio

Construction 247
Santiago Alberico, Joachim Coche, Vahe Sahakyan, and Omar
Zulaica

10 Benchmark-Relative and Absolute-Return Are the Same

Thing: Conditions Apply 275
Robert Scott

11 Factors and Sectors in Asset Allocation: Stronger

Together? 291
Marie Brière and Ariane Szafarz
 CONTENTS
   xi

Part IV Asset Classes for Public Investors 311

12 The Impact of Benchmark Investing by Institutional

Investors on International Capital Allocations 313
Claudio Raddatz, Sergio L. Schmukler, and Tomás Williams

13 Equity Markets Integration and Active Portfolio

Management 341
Gabriel Petre, Olga Sulla, and Daniel Vela Barón

14 Government Bond Clienteles and Yields 369

Jianjian Jin, Francisco Rivadeneyra, and Jesús Sierra

Index 393
 Notes on Contributors

Santiago Alberico received his BA in Economics from Instituto

Tecnológico Autónomo de México (ITAM) and his master’s in
Mathematical Finance from the University of Toronto in 2011. He has
worked in different departments of the Markets Division at the Central
Bank of Mexico, ranging from the liquidity forecasting office, domestic
FX trading, G10 FX and commodities trading, and heading the asset allo-
cation department. He is now working at the Bank of France in an
exchange programme (the first of its kind) as a Fixed Income Portfolio
Manager.
Jacob Bjorheim is a lecturer at the Faculty of Business and Economics at
the University of Basel. He is also a Visiting Fellow with the Department
of Philosophy, Logic and Scientific Method at the London School of
Economics (LSE). Between 2007 and 2017, Jacob was Head of Asset
Management with the Bank for International Settlements (BIS). He holds
an MSc from the University of St. Gallen (Switzerland) and an MSc and a
PhD from the LSE.
Marie Brière PhD, is head of the Investor Research Center at Amundi,
France. She is also an affiliate professor at Paris Dauphine University and
an associate researcher at the Centre Emile Bernheim at Solvay Brussels
School of Economics and Management, Université Libre de Bruxelles.
Her scientific articles have been published in international academic jour-
nals including the Financial Analyst Journal, Journal of Banking and
Finance, Journal of International Money and Finance, World Development,

xiii
xiv Notes on Contributors

and so on. She received the Markowitz Award for her article with Zvi
Bodie on “Sovereign Wealth and Risk Management,” published in the
Journal of Investment Management.
Joachim Coche is Head of Financial Analysis at the BIS. This unit pro-
vides services to the BIS Banking Department and its customers in the
form of analytical, technical, and advisory support, as well as information
on the business activity of the department. He joined the BIS in 2007 as
an Asset Management Specialist supporting central bank clients in strate-
gic asset allocation, asset liability management, and outsourcing. Before
joining the BIS, he worked for the World Bank Treasury and the European
Central Bank (ECB). He has a master’s and a doctorate in economics from
the University of Osnabrück, Germany.
Daniel E. Diaz is an Analyst of the Research and Analysis Group at the
International Investment Department of Banco de la República, the cen-
tral bank of Colombia. His duties encompass research, development, and
the creation of quantitative tools to support the management of Colombia’s
foreign reserves and sovereign wealth funds. Among the team’s most rel-
evant responsibilities is the development of quantitative tools for the asset
allocation of the portfolios. He holds a BSc in Physics from Universidad
Nacional de Colombia in Bogotá and is finishing an undergraduate degree
in Economics and an MSc in Physics from this university.
Julián David García-Pulgarín is Professor of Financial Engineering at
the Universidad Autónoma de Bucaramanga UNAB (Colombia). Prior to
UNAB, he was a Senior Analyst of the Research and Analysis Group at the
International Investment Department of Banco de la República, the cen-
tral bank of Colombia, where his duties encompassed research, develop-
ment, and the creation of quantitative tools to support the management
of Colombia’s foreign reserves and sovereign funds. He holds a BA in
Industrial Engineering from Universidad de Antioquia (Colombia) and an
MSc in Applied Mathematics with a focus on stochastic processes from
EAFIT University (Colombia).
Erik Hennink is a Senior Quantitative Financial Analyst at the Scenario
Modelling and Research Department of Ortec Finance, where he special-
izes in time series modeling for external clients. The aim of Ortec Finance
is to improve financial decision-making using a combination of mathemat-
ical models, IT, and market knowledge for public investors (e.g. pension
funds). Before joining Ortec Finance, Erik used to work in Rabobank
International as a Quantitative Risk Analyst for the Derivatives Modelling
 Notes on Contributors 
   xv

and Research Department. He holds a master’s in quantitative finance

from the Erasmus University of Rotterdam.
Jianjian Jin is a Senior Analyst in the Research Division of the Funds
Management and Banking Department at the Bank of Canada. His pri-
mary research interests are the impact of macroeconomy and unconven-
tional central bank policy on returns in financial markets and investors’
asset allocation. He has also worked on topics such as stochastic volatility
consumption-based asset pricing models, variance risk premium puzzles
and so on. Jin received his PhD in Economics from Northwestern
University.
Alex Joia is Head of Portfolio Management at the Banking Department
of the BIS. Prior to joining the BIS in August 2000, Alex worked at
Kleinwort Benson in London. Alex graduated in physics at the University
of Bristol and gained his PhD at the Department of Applied Mathematics
and Theoretical Physics at Cambridge University. Alex has worked in the
Basel and Hong Kong offices of the BIS and has had both client- and
market-facing responsibilities.
Mark Knezevic is a Senior Asset Management Specialist at the
Representative Office for Asia and the Pacific of the BIS, Hong Kong.
Prior to joining the BIS in 2015, Knezevic spent ten years in the financial
market areas at the Reserve Bank of Australia (RBA), which included roles
in reserves management and the RBA’s pension fund, and over two years
at the New York representative office managing the USD and CAD com-
ponents of Australia’s official foreign reserves. Knezevic has a master’s in
Applied Finance from Macquarie University and a Professional Risk
Manager (PRM) designation.
Michael G. Papaioannou is a Deputy Division Chief in the Debt and
Capital Markets Instruments, Monetary and Capital Markets Department
of the International Monetary Fund (IMF). While at the IMF, he served
as a Special Adviser to the Governing Board of the Bank of Greece and has
led numerous IMF missions on designing and implementing sovereign
asset and liability management frameworks, establishing and managing
sovereign wealth funds (SWFs), and developing economic and financial
policies for developed and emerging economies. Prior to joining the IMF,
he was a Senior Vice President for International Financial Services and
Director of the Foreign Exchange Service at the WEFA Group (Wharton
Econometrics Forecasting Associates) and served as Chief Economist of
the Council of Economic Advisors of Greece.
xvi Notes on Contributors

He has also taught as Adjunct Associate Professor of Finance at Temple’s

FOX School of Business and was a Principal Research Fellow at the
University of Pennsylvania, Department of Economics, LINK Central. He
holds a PhD in Economics from the University of Pennsylvania and an MA
in Economics from Georgetown University. He has authored or coau-
thored numerous books and articles in the areas of international finance
and applied econometrics.
Gabriel Petre is responsible for developing asset allocation strategies for
the World Bank’s staff retirement fund. As part of his work, he has also
been involved in advising central banks of developing countries on reserves
management issues, governments from developing countries on invest-
ment policy issues related to public pension funds, and official institutions
of commodity-rich countries in setting up sovereign wealth funds. He
joined the World Bank Treasury in July 2006. Before, he worked for three
years at the National Bank of Romania, as part of the team in charge of the
foreign reserves portfolio. He has an MBA from Georgetown McDonough
School of Business and is a CFA charterholder.
Cristian Porras is an Economist of the Research and Analysis Group at
the International Investment Department of Banco de la República, the
central bank of Colombia. His duties encompass research, development,
and the creation of quantitative tools for assessing the adequacy level of
foreign reserves and its currency composition. He is an Economist and a
candidate for master’s degree in Economics from the Universidad
Externado de Colombia.
Francesco Potente has a degree in Economics and is a CFA charter-
holder. He has worked as a market analyst in the Investment Management
Division at the Bank of Italy where, inter alia, he has contributed to stud-
ies on various portfolio management and derivative pricing issues, as well
as to the development of tools for supporting the investment decision
process. He has also participated in Eurosystem working groups. He has
direct experience in foreign exchange market trading and portfolio man-
agement. He is an Advisor in the General Financial Supervision and
Regulation Directorate.
Claudio Raddatz is the Chief of the Global Financial Stability Analysis
Division in the International Monetary Fund’s (IMF) Monetary and
Capital Markets Department. Previously, he was the Director of Financial
Policy (2014–2017) and Head of Economic Research (2011–2014) at the
 Notes on Contributors 
   xvii

Central Bank of Chile, Senior Economist at the World Bank Development

Economics Research Group (2008– 2011), and Economist at the same
institution (2003–2008). Mr. Raddatz has numerous academic publica-
tions in macro-financial issues. He holds a BSc and an MSc from the
University of Chile and a PhD in Economics from the Massachusetts
Institute of Technology (2003).
Bayasgalan Rentsendorj is a Senior Membership Manager at the
International Forum of Sovereign Wealth Funds (IFSWF), based in
London, England. Prior to joining IFSWF, he was a Senior Research
Officer at the International Monetary Fund in Washington, DC, where he
published research on SWF strategic asset allocations and managed a
knowledge-sharing platform for IFSWF member SWFs. He has also
worked with the Asian Development Bank and the Bank of Mongolia
(The Central Bank). He received his MBA with distinction from the
University of Oxford and is a graduate of Williams College in Massachusetts,
where he earned an MA in Policy Economics.
Francisco Rivadeneyra is a Research Advisor in the Funds Management
and Banking Department at the Bank of Canada. His research overlaps
payments and financial economics. His payments research focuses on the
implications of recent technological innovations for central bank mandates
and the development of computational tools to measure risk and efficiency
of payments systems. His financial economics work focuses on tools for
the management of domestic debt and foreign reserves portfolios. He
holds a PhD in Economics from the University of Chicago.
Marco Ruíz is the Head of foreign reserves at Banco de la República, the
central bank of Colombia. In this position, he is responsible for the invest-
ment of the country’s foreign reserves and sovereign wealth funds. Before
becoming the Head of the department, he worked in the portfolio man-
agement team, first as a Senior Portfolio Manager and later as the Deputy
Head of portfolio management. Mr. Ruiz holds a BA in Economics from
Universidad de los Andes in Bogotá and an MBA from New York
University’s Stern School of Business. Marco is a CFA charterholder.
Vahe Sahakyan joined the BIS in 2008 as an Asset Management Specialist
supporting BIS internal committees and central bank clients in strategic
and tactical asset allocation, asset liability management, and outsourcing.
Before joining the BIS, he worked for the World Bank and the Central
xviii Notes on Contributors

Bank of Armenia and taught econometrics and financial market micro-

structure at the Universitat Pompeu Fabra. Vahe holds several titles: PhD
in Mathematical Methods (Yerevan State University), PhD candidate in
Quantitative Finance (University of Zurich), MA in Economics (Central
European University), and MSc in Finance (Universitat Pompeu Fabra).
Antonio Scalia PhD, is Deputy Head of the Market Operations
Directorate at the Bank of Italy and a member of the Market Operations
Committee of the ECB. Previously, he has been Head of the Risk
Management Division at the Bank of Italy, a consultant in technical assis-
tance missions of the World Bank-IMF in Central Europe, and an expert
in working groups of the BIS. His scientific articles have been published in
international academic journals including Journal of International Money
and Finance, Review of Finance, Journal of Empirical Finance, and Journal
of Fixed Income.
Sergio L. Schmukler is the Lead Economist at the World Bank’s
Development Research Group. His research area is international finance
and international financial markets and institutions. He obtained his PhD
in Economics from the University of California at Berkeley in 1997. He is
a member of the Money and Finance Research Group and Treasurer of the
Latin America and Caribbean Economic Association. He has visited sev-
eral central banks and institutions, taught at the of University of Maryland,
worked at the IMF Research Department, worked as Associate Editor of
the Journal of Development Economics, and has participated in several
other editorial boards.
Robert Scott has been with the Official Institutions team at Schroders
since 2008 responsible for training, advisory, research, and relationship
management with official institutions around the world. Previously he
spent ten years at the Bank for International Settlements (BIS), as Head of
Portfolio Management, having earlier served in the Monetary and
Economics Department and Portfolio Management of the BIS. He started
his investment career in 1994 at Bank Credit Analyst Research Group as
Quantitative Analyst and later as Editor of the BCA Fixed-Income
Strategist. Education—CFA designation in 2003; BComm (Finance), BA
(Philosophy) Dalhousie University, Canada; MSc. Finance Concordia
University, Canada.
Jesús Sierra is Director at the Emerging Risks and Data Analytics
Department at the Canada Deposit Insurance Corporation (CDIC),
where he oversees the stresstesting of small and medium-sized banks. His
 Notes on Contributors 
   xix

current research focuses on Exchange Traded Funds’ performance from a

risk-management point of view. His previous research studied the impact
of international capital flows on bond risk premia, the macroeconomic
determinants of flows into mutual funds and the drivers of time variation
in active risk exposures of fixed-income portfolios. He was previously
Principal Researcher at CDIC and a Senior Analyst at the Bank of Canada.
He holds a PhD from the University of Southern California.
Olga Sulla is a Senior Finance Officer with QSA Department at the
World Bank Treasury. She performs strategic asset allocation, leads analysis
on fixed income and equity for internal and external clients, and develops
diversification strategies for portfolios of central banks’ FX reserves. Prior
to this, Olga worked extensively on private sector and financial markets
development in East Asia, Europe, Africa, and Latin America, as well as at
the IMF’s Western Hemisphere Department as a Senior Economist. Olga
started her career at the Bank of Israel’s monetary policy and capital mar-
kets department and published in economics and finance, including in
macroeconomics modeling.
Ariane Szafarz is a professor of finance at Université libre de Bruxelles
(ULB), Belgium, and a co-director of the Centre for European Research
in Microfinance (CERMi). She holds a PhD in Mathematics and currently
works on financial markets and banking. She published articles in, for
example, European Economic Review, Journal of Banking and Finance,
Journal of Business Ethics, Journal of Empirical Finance, Journal of
International Money and Finance, and Review of Finance. Her co-authored
article “Selectivity and Transparency in Social Banking: Evidence from
Europe” received the 2016 Warren Samuels Prize awarded at the ASSA
Meetings by the Association for Social Economics.
Marcelo Yoshio Takami has worked at the Banco Central do Brasil
(BCB) since 2003 and is currently responsible for the credit risk manage-
ment of the BCB. He was formerly a visiting fellow at the Bank for
International Settlements (BIS). Dr. Takami graduated in Computer
Engineering and holds a PhD in Economics from the University of Sao
Paolo. He has published a number of articles about financial risk and
financial stability.
Daniel Vela Barón is a Financial Officer at the Quantitative Solutions,
Strategic Asset Allocation, and Analytics Department (QSA) in the World
Bank Treasury, where he specializes in risk modeling and strategic asset
xx Notes on Contributors

allocation for internal and external clients. Before joining the World Bank,
Daniel used to work in Banco de la República (Central Bank of Colombia)
as a Senior Quantitative Analyst for the International Investments
Department. He holds a Master of Finance from MIT, an MS in
Engineering, and a BS in Industrial Engineering from Universidad de Los
Andes. He is an FRM and CFA® charterholder.
Tomás Williams is Assistant Professor of International Finance at George
Washington University in Washington, DC. His main fields of research are
International Finance, Financial Economics, and Empirical Banking. He
has a special interest in financial intermediaries and how they affect inter-
national capital flows and economic activity. More specifically, he has been
working on how the use of well-known benchmark indexes by financial
intermediaries affects both financial markets and real economic activity.
Omar Zulaica is Asset Management Specialist at the BIS. His responsi-
bilities include providing reserve management advisory to central banks
and supporting the Bank’s asset management activities, such as the
enhancement of the investment process and strategic asset allocation—all
with special focus on the quantitative framework. He was formerly Head
of Strategic Asset Allocation at the Central Bank of Mexico and before
that Head of Tactical Asset Allocation. His academic credentials are a BSc
in Actuarial Science from Instituto Tecnológico Autónomo de México
(ITAM)—where he worked as part-time professor—and an MSc in
Financial Economics from the University of Oxford in the United
Kingdom; he graduated from both with awards.
 List of Figures

Fig. 1.1 Average annual growth of adequate level of reserves and

returns of various asset classes 11
Fig. 1.2 Explanatory factors for the liability (reserve adequacy measure) 16
Fig. 1.3 Liabilities (reserve adequacy measure) and combination of
factors with highest explanatory power (in US dollars million) 17
Fig. 1.4 Unrestricted portfolio 18
Fig. 1.5 Currency composition of unrestricted portfolio 18
Fig. 1.6 Investable portfolio asset allocation 19
Fig. 1.7 Investable portfolio currency composition (a) and sector
allocation (b) 19
Fig. 1.8 ALM portfolio versus asset-only efficient frontier 20
Fig. 1.9 Long-term investment tranche asset allocation 21
Fig. 2.1 Expected growth coefficient versus the Kelly fraction 35
Fig. 2.2 Asset managers’ excess returns distributions. The units of the
Y-axis are number of funds 37
Fig. 2.3 Terminal portfolio value applying the Kelly criterion:
a) Short-time horizon (graphs at the left), b) Long-time
horizon (graphs at the right) 39
Fig. 2.4 Allocation of the asset managers within the same portfolio 40
Fig. 3.1 Cumulative returns, ECB’s US dollar reserves, 2006–2010:
benchmark versus aggregated portfolio. On the y axis,
cumulative returns are expressed as an index 58
Fig. 3.2 Duration contribution to outperformance 59
Fig. 3.3 Duration exposure 60
Fig. 3.4 Curvature contribution to outperformance 61
Fig. 3.5 Curvature exposure 62
Fig. 3.6 Spread contribution to outperformance 64

xxi
xxii LIST OF FIGURES

Fig. 3.7 Spread exposure 65

Fig. 3.8 Security selection contribution to outperformance 66
Fig. 4.1 Selected SWF SAA changes, 2015 versus 2010. The units of
the Y-axis are % 76
Fig. 4.2 Selected SWF SAAs, 2015. The units of the Y-axis are % 76
Fig. 4.3 Selected SWF SAAs, 2010. The units of the Y-axis are % 77
Fig. 4.4 SAAs by type of SWF, end-2015 (or latest available data) 78
Fig. 4.5 SAAs by type of SWF, end-2010 (or June 2011) 79
Fig. 4.6 Annualized (five-year) returns of selected SWF portfolios 80
Fig. 4.7 Historical returns of selected SWFs  82
Fig. 4.8 Selected SWF owner countries’ budget balances (annualized,
five years) 83
Fig. 4.9 Typical funding sources and withdrawal motives 92
Fig. 5.1 Illustration of parameter A  107
Fig. 5.2 Illustration of factor projection 109
Fig. 5.3 Evolution of estimate shadow-curve factors. The units of the
Y-axis are % 112
Fig. 5.4 Cumulative return of factor portfolios 122
Fig. 6.1 Cross-market carry strategies: cumulative returns indices 143
Fig. 6.2 Cross-market carry strategies: factor portfolio returns and
correlations147
Fig. 6.3 Cross-curve carry strategies: cumulative returns and
correlations149
Fig. 6.4 Cross-curve and cross-market carry strategies: cumulative
returns and correlations 153
Fig. 7.1 Notional amount of CDS contracts outstanding: total versus
sovereigns165
Fig. 8.1 Graphical presentation of the credit spreads of the individual
IG and HY rating for different sample periods 225
Fig. 8.2 A graphical presentation of the long-term (LT) model
expected CSTS of the individual IG and HY ratings from
Table 8.7232
Fig. 8.3 A graphical presentation of the long-term (LT) model
expected CSTS of the individual IG and HY ratings from
Table 8.7, with confidence intervals 234
Fig. 9.1 US real GDP quarterly annualised GDP growth and output
gap250
Fig. 9.2 US probability of recession implicit in selected variables 250
Fig. 9.3 Macroeconomic fragility index 253
Fig. 9.4 Financial turbulence index 253
Fig. 9.5 Systemic risk index 254
Fig. 9.6 Composition of optimised portfolios for a target duration of
four years264
 LIST OF FIGURES
   xxiii

Fig. 9.7 Risk-return plots of regime portfolios versus standard mean-

variance and Bayesian portfolios 265
Fig. 9.8 Evolution of cumulative excess returns of regime portfolios
over standard mean-variance portfolios 268
Fig. 10.1 Traditional benchmark-relative approaches lag absolute-returns
for two- and five-factor portfolios. Two-Factor Portfolio 278
Fig. 10.2 Constraints tend to undermine information ratios—alpha and
TEV for two- and five-factor portfolios 280
Fig. 10.3 Risk and return for two- and five-factor portfolios 282
Fig. 10.4 The bear-market test 286
Fig. 11.1 Efficient frontiers: Sector investing and factor investing 298
Fig. 11.2 Efficient frontiers with combinations 302
Fig. 12.1 Assets under management of non-bank institutional investors,
2001–2013315
Fig. 12.2 US mutual fund assets by fund type 316
Fig. 12.3 Outflows/inflows from US equity mutual funds from ICI 317
Fig. 12.4 Direct benchmark effect: The Case of Israel 326
Fig. 12.5 MSCI upgrade of Qatar and the United Arab Emirates 328
Fig. 12.6 Direct benchmark effect and asset prices: Argentina equity
market329
Fig. 12.7 Sensitivity effect of country flows 332
Fig. 12.8 Capital flows and benchmark weights 334
Fig. 13.1 Portion of sovereign wealth funds investing in each asset class 343
Fig. 13.2 Asset allocation of selected institutional investors, percentage
of total portfolio 343
Fig. 13.3 Sovereign wealth funds’ assets under management, USD
trillion344
Fig. 13.4 World trade as a percentage of GDP 344
Fig. 13.5 Market capitalization of globally listed companies 345
Fig. 13.6 Actual MSCI emerging market index versus overweighed
MSCI emerging market with additional 3% in non-integrated
countries358
Fig. 14.1 Quarterly GoC holdings as the share of the total outstanding
by domestic and international investors 374
Fig. 14.2 Average portfolio duration of Canadian fixed-income mutual
funds. The units of the Y-axis are years 378
Fig. 14.3 Distribution of portfolio duration of Canadian fixed-income
mutual funds. The units of the Y-axis are years 379
Fig. 14.4 Portfolio duration of foreign official investors. The units of the
Y-axis are years 379
Fig. 14.5 Duration profile of foreign official investors. The units of the
Y-axis are years 380
 List of Tables

Table 1.1 Descriptive statistics of the deviations of each portfolio

returns from the adequacy level of reserves 20
Table 2.1 Amount allocated to active asset managers 38
Table 2.2 Results for allocation for the overall active management
program40
Table 2.3 Results for allocation of the asset managers within the same
portfolio41
Table 3.1 Portfolio 53
Table 3.2 Benchmark 53
Table 3.3 Differential exposure 53
Table 3.4 Portfolio adjusted—partial durations 55
Table 3.5 Differential exposure adjusted 55
Table 3.6 Portfolio adjusted—weights 55
Table 3.7 Duration exposure synthetic indicators 67
Table 3.8 Curve exposure synthetic indicators 67
Table 3.9 Spread exposure synthetic indicators 68
Table 3.10 Security selection indicators 68
Table 3.11 Active positions—average time horizon (weeks) 69
Table 4.1 Historical returns of selected SWFs (percent) 81
Table 4.2 Policy purpose and performance of SWFs 85
Table 4.3 Fiscal rules in selected countries with SWFs 87
Table 4.4 Types of funding and withdrawal rules 89
Table 4.5 Typical fiscal rules and SWF funding and withdrawal
frameworks94
Table 5.1 Data sources 110
Table 5.2 Coefficient estimates governing the time-series dynamics
(Eqs. 5.4 to 5.6) 113

xxv
xxvi LIST OF TABLES

Table 5.3 In-sample backtest full period 115

Table 5.4 Carry 117
Table 5.5 In-sample backtest expected return—part 1 119
Table 5.6 In-sample backtest expected return—part 2 120
Table 5.7 Out-of-sample backtest (1990 to 2016) 123
Table 5.8 In-sample backtest (1990 to 2016) 127
Table 6.1 Data sources of sovereign bond yields 136
Table 6.2 Summary statistics for ten-year zero coupon bonds (annual
basis)137
Table 6.3 Summary statistics of excess carry signals by country and
maturity139
Table 6.4 Cross-market carry strategies: full sample 144
Table 6.5 Cross-market carry strategies: 1983–2016 146
Table 6.6 Cross-curve carry strategies 150
Table 6.7 Cross-curve and cross-market carry strategies 154
Table 7.1 Classification of sovereigns according to investment class 163
Table 7.2 Descriptive statistics for CDS spreads 167
Table 7.3 Description of explanatory variables 168
Table 7.4 Granger-causality test 171
Table 7.5 Set of eligible explanatory variables 173
Table 7.6 GMM results 176
Table 7.7 ARMA results 180
Table 7.8 GMM results with lagged-explanatory variables 184
Table 7.9 GMM results without the criterion “with at least one
10%-significant coefficient with expected signs according to
Table 7.3”186
Table 7.10 GMM results substituting Theil’s U1 for Adjusted R2 in
criteria (2) “with the highest Adjusted R2”188
Table 7.11 GMM results substituting Theil’s U2 for Adjusted R2 in
criteria (2) “with the highest Adjusted R2”190
Table 7.12 GMM results substituting percent hit misses (PHM) for
Adjusted R2 in criteria (2) “with the highest Adjusted R2”192
Table 7.13 5%-significant level Granger-causality test 194
Table 7.14 GMM results—5%-significant level Granger-causality-test
set of eligible variables 196
Table 7.15 Coefficient estimators for sp500t across different sub-samples 198
Table 7.16 Coefficient estimators for sp500t across different sub-
samples 5%-significant level Granger-causality-test set of
eligible variables 200
Table 7.17 Adjusted R2 across different periods 202
Table 7.18 Theil’s U1 across different periods 203
Table 7.19 Theil’s U2 across different periods 204
Table 7.20 PHM across different periods 205
 LIST OF TABLES
   xxvii

Table 7.21 ARMA models’ goodness-of-fit statistics 206

Table 7.22 Lagged-explanatory variable models’ S&P500 estimators
and goodness-of-fit statistics 208
Table 8.1 The estimated long-term expected credit spreads and excess
returns238
Table 8.2 The R2 of the marginal and cumulative default probabilities
of the original Moody’s data and the estimated model
values from optimization of Eq. 8.8 238
Table 8.3 The Nelson–Siegel fitted average of the US government
bond yields of particular maturities for multiple samples 238
Table 8.4 Descriptive statistics of the individual IG 10Y+ and HY
all-maturity (all) rating benchmark for two sample periods 239
Table 8.5 The findings of three papers that have quantified the
liquidity premium in % of ten-year corporate bonds for
different ratings 240
The assumptions for the par yield ci (T ) of the defaultable
f
Table 8.6
corporate bond with annual, f = 1, coupon payments, rating
i, and maturity T240
The long-term expected par credit spreads si (T ) of
1
Table 8.7
Eq. 8.7 for maturities T 1–10 years (panel A) and
11–20 years (panel B), and rating i241
Table 8.8 The expected credit excess returns over government bonds
based on Eq. 8.11 for maturities T 1–10 years (panel A)
and 11–20 years (panel B) 241
Table 9.1 T-statistics of β coefficient in the predictive regression using
monthly local currency returns 256
Table 9.2 T-statistics of β coefficient in the predictive regression of
12-month rolling volatility using monthly local currency
returns259
Table 9.3 Alternative assumptions used for portfolio construction 262
Table 9.4 Absolute risk-return properties of standard, Bayesian, and
regime portfolios 266
Table 9.5 Excess returns relative to the standard mean-variance
portfolio over the out-of-sample period 270
Table 10.1 Formal optimisation problems for absolute-return and
benchmark-relative276
Table 10.2 Sample portfolios under various constraints—two-factor
model279
Table 11.1 Crisis periods 294
Table 11.2 Descriptive statistics, sectors, and factors, July 1963–
December 2016 295
Table 11.3 Correlation matrices, sectors, and factors, July 1963–
December 2016 297
xxviii LIST OF TABLES

Table 11.4 Contest between sector investing and factor investing 300
Table 11.5 Combining sector investing and factor investing 303
Table 11.6 Sector + factor portfolios beating the market 304
Table 11.7 Factor + sector long-only portfolios beating the market,
detailed portfolio composition 306
Table 11.8 Factor + sector long-short portfolios beating the market,
detailed portfolio composition 307
Table 12.1 Quantitative benchmark effects on capital flows 324
Table 12.2 Country flows versus benchmark flows 330
Table 13.1 Augmented Dickey Fuller test 351
Table 13.2 Gregory-Hansen co-integration test with structural breaks
(p-value) among different regions 352
Table 13.3 Correlation among selected regions 357
Table 13.4 Absolute return analysis for developed market index 359
Table 13.5 Absolute return analysis for emerging market index 360
Table 13.6 Relative return analysis for developed market index 360
Table 13.7 Relative return analysis for emerging market index 360
Table 13.8 Augmented Dickey Fuller test for industries 361
Table 13.9 Gregory-Hansen co-integration test with structural breaks
(p-value) among industries in developed countries 362
Table 13.10 Gregory-Hansen co-integration test with structural breaks
(p-value) among industries in emerging countries 363
Table 13.11 Absolute return analysis for emerging market index with
industries364
Table 13.12 Relative return analysis for emerging market index with
industries364
Table 14.1 Distribution of holdings of Government of Canada
marketable bonds among domestic and international
investors373
Table 14.2 Percentage of outstanding of bonds held by Canadian and
international investors 375
Table 14.3 Summary statistics of the GoC bond holdings of foreign
official investors and Canadian mutual funds 376
Table 14.4 Summary statistics of yield changes and bond flows 381
Table 14.5 Panel regression for the full sample of investor and duration
groups383
Table 14.6 Panel regression for the short-duration (1.5- to 5.5-year)
bond sector 385
Table 14.7 Panel regression for the medium-duration (5.6 and
9.5-year) sector 386
Table 14.8 Panel regression for the long-duration (9.6- and 30-year)
bond sector 388
 PART I

Foreign Reserves Management

Strategies: Implementation,
Performance and Governance
 CHAPTER 1

Hedging Potential Liabilities of Foreign

Reserves Through Asset Allocation

Daniel E. Diaz, Julián David García-Pulgarín,

Cristian Porras, and Marco Ruíz

1.1   Introduction
The purpose of this chapter is to explore further the topic of asset-liability
management (ALM) for foreign reserves. Although several central banks
use ALM to determine the asset allocation of the foreign reserves, mostly
they do so in order to cover defined liabilities such as government or cen-
tral bank debt. However, most countries hold foreign reserves as a buffer
for a substantial shock to the balance of payments, which includes private
and public sector flows. For instance, foreign reserves may help reduce the
impact of large, potentially disruptive portfolio outflows from the equity
and bond market on the rest of the economy. Therefore, in our opinion,
ALM for foreign reserves should take into consideration all of the relevant
macroeconomic vulnerabilities that might affect the balance of payments.
This chapter proposes an approach to quantify and to hedge those lia-
bilities, using data from Colombia as an illustration. The chapter seeks to
contribute to the ALM discussion by defining the liabilities of foreign

D. E. Diaz • J. D. García-Pulgarín • C. Porras • M. Ruíz (*)

Banco de la República, Bogotá, Colombia
e-mail: mruizgil@banrep.gov.co

© The Author(s) 2018 3

N. Bulusu et al. (eds.), Advances in the Practice of Public Investment
Management, https://doi.org/10.1007/978-3-319-90245-6_1
4 D. E. DIAZ ET AL.

reserves and their volatility, not only to determine the size of the liquidity
tranche but also to find the portfolio that most appropriately hedges those
liabilities. As a result, both the currency composition and the allocation of
the portfolio across different asset classes depend on their ability to hedge
the unique liabilities of each country. In the same fashion as Bonza et al.
(2010) and Alhumaidah (2015), this chapter proposes a two-tranche
approach. For the asset-liability tranche, a country-specific reserve ade-
quacy measure is used to proxy for the liabilities of reserves, and the objec-
tive of portfolio construction is to hedge those liabilities. Hence, the size
of the asset-liability tranche should be roughly the same as that of the lia-
bilities. For the long-term investment tranche, whose size is determined
by the excess of total reserves over liabilities, a traditional asset-only
approach aims for wealth maximization, given that the likelihood of liqui-
dating this tranche in the short term is theoretically low.
The next section summarizes relevant literature on ALM for interna-
tional reserves portfolios. The third section reviews the work on reserve
optimality and reserve adequacy and explains in detail the measure chosen
to quantify the liabilities of foreign reserves. The fourth section explains
the methodology and the fifth section describes the data and the sources.
The sixth section shows the results. The seventh section concludes.

1.2   Asset-Liability Management in International

Reserves Portfolios
The last two decades have seen a growing trend in international reserve
accumulation in most countries around the world (Berkelaar et al. 2010),
which has caused a great interest in strategic asset allocation (SAA) for
international reserve portfolios, considering that SAA is the main source
of return and risk for any kind of portfolio (Brinson et al. 1986).
There are two widely-used approaches to asset allocation: asset-only
optimization (AO) and ALM. In the former, the purpose is to obtain the
highest possible return for an acceptable level of risk, regardless of the
liabilities (outflows of future money, both expected and unexpected, if
they exist). By contrast, the ALM approach explicitly takes into account
future cash flows or obligations and constructs portfolios that reduce the
volatility of the difference between the present value of the liabilities and
that of the assets.
 HEDGING POTENTIAL LIABILITIES OF FOREIGN RESERVES… 5

Cash flow matching is the most traditional and conservative ALM

methodology (Fabozzi 2007). It attempts to match liability cash flows
with coupon and principal payments of fixed income assets in the portfo-
lio. Risk matching or immunization is the other traditional ALM method-
ology. Its objective is to match the interest rate and liquidity risks of
liabilities with those of the assets. Immunization outperforms cash flow
matching when it is not possible to find assets in the financial market that
pay cash flows identical to those of the liabilities.
The ALM approach is extensively used in defined-benefit pension plans,
whose objective is to cover future pension cash flows through contribu-
tions and returns from the pension portfolio and to maximize the surplus
once the projected liabilities are funded. Banks also apply ALM to con-
struct a portfolio that replicates the duration of their liabilities.
In the case of foreign reserves management, the choice between AO
and ALM depends on the specific objective of the central bank. When a
central bank has a broad mandate such as reducing the probability of
occurrence of balance of payments crises or when the liabilities are difficult
to estimate, the AO approach is preferred. On the other hand, when the
central bank has well-defined liabilities that it wants to hedge, for instance,
government or central bank debt, the preferred approach is ALM.
In recent years, there have been a number of studies applying ALM to
the construction of foreign reserve benchmarks and an increasing number
of countries have adopted this approach. In the case of Canada (Rivadeneyra
et al. 2013), international reserves are managed using an ALM framework
that requires currency and duration matching of international reserves and
foreign currency liabilities issued. The model jointly optimizes the mix of
assets and liabilities across currencies, instruments, and tenors that maxi-
mize the return of the portfolio subject to duration and currency match-
ing. Canada’s foreign exchange reserves are financed by the federal
government. Further, the primary objective of foreign reserves in Canada
is to help to promote orderly conditions for the Canadian dollar in cur-
rency exchange markets and provide foreign currency liquidity to the gov-
ernment. Thus, the appropriate liability is defined by the debt instruments
issued to finance the reserves account. As a result, applicability of the ALM
approach is straightforward.
According to Bhattacharya et al. (2010), the Reserve Bank of India
incorporates an ALM model that consists of a balance sheet for each
currency separately, allowing for currency transfers and incorporating
Another random document with
no related content on Scribd:
 Verdi was a man of the people, loving Italy and being loved in
return, a master of voice, ready to take good suggestions to improve
his work, always kind, high-minded, and generous. He knew the
orchestra and wrote for it in a way that not only gave, in his last three
masterpieces, a new flavor to Italian opera, but led the way for future
composers.
 Boito and His “Mefistofele”

Arrigo Boito (1842–1918), journalist, poet, and composer sprang

into prominence with his Mefistofele, in which the Russian singer,
Chaliapin, has attracted huge audiences at the Metropolitan. When it
was first given in Italy, the audiences missed the coloratura arias,
and the critics were very hard on the young composer. So he went
back to journalism for many years. His next opera Nero has a gory
plot, but is real and not embroidered as were most of the Italian
operas. Boito had studied in Germany and had absorbed much of the
realism and truthfulness that Gluck and Wagner, taught. Nero had
an elaborate first performance (1924) by the celebrated Arturo
Toscanini, one of the greatest living conductors, at La Scala in Milan.
It is a tremendous stage spectacle, surpassing in scenic effect many
of the older melodramas.
 “Cavalleria Rusticana” and “I Pagliacci”

In 1890 the first truly realistic opera was written in Italy. A prize
was offered by the publisher Sonzogno and an unknown man, Pietro
Mascagni, won it with Cavalleria Rusticana (Rustic Chivalry). He
was born in 1863, the son of a baker. He was a musical boy, but his
father wished him to be a lawyer, so he had to work at the piano in
secret. One day when he had been locked up by his father who did
not want him to practise, he was discovered by his uncle, who
sympathized with him and took him to Count Florestan, who helped
the young musician to study in Milan.
Mascagni’s work in Cavalleria Rusticana was vivid and he used
both the old and the new style of writing. It is full of the most
entrancing melody (the Intermezzo, the Brindisi, or drinking song,
and Santuzza’s aria, Voi lo sapete). He also wrote Iris and Amico
Fritz, which never equalled Cavalleria.
With Ruggiero Leoncavallo (1858–) it was different, for only after
writing a number of operas did he produce a success in the world-
famous I Pagliacci. He wrote the tragic story of these strolling
players as well as the music, which is not as popular in style as
Cavalleria, but it is superbly put together and very dramatic. As
these operas are both short, they are often performed together. The
rôle of Canio (I Pagliacci) was one of Caruso’s masterpieces. How
wonderful to think that his voice has been preserved for the future
generations through his records of which Ridi Pagliaccio (Laugh
Clown) is one of the finest. It is generally admitted that Caruso’s
voice was the most glorious of our age, and certainly there was no
artist more idolized than he. In this same opera Antonio Scotti’s
performance of the famous Prologue is equally beautiful.
 Giordano

Umberto Giordano (1867) goes into peculiar realms for subjects

for his operas. He uses local political intrigues and literature for his
themes, and is known especially for his André Chenier and Fedora
which are given in many opera houses of the world. In Siberia he
uses folk songs of Russia. He has recently set The Jest by Sem Benelli
librettist of L’Amore dei Tre Re (The Love of Three Kings) by Italo
Montemezzi.
 Puccini the Popular Idol

Now we come to a delightful opera maker, Giacomo Puccini

(1858–1924). He is the greatest modern Italian with the exception of
Verdi. He has a distinctive touch that gives him individuality. He
keeps a nice balance between voice, orchestra and melody. His music
is always full of color and feeling. His themes, for the most part,
touch the heart and have gained wide popularity.
His first opera was Manon Lescaut, the same story which
Massenet used in his delightful opera Manon; La Bohème is his next
and is often said to be his best. It is a tale of artist life in the Latin
Quarter of Paris and is full of romance, color, gaiety and sadness. His
story is taken from Murger’s Vie de Bohème, which was a fortunate
choice. Madame Butterfly is another of his glittering successes. It
has a decided Japanese flavor in its musical phrases. It is based on a
story by John Luther Long, which was made into a play by David
Belasco. Butterfly was one of Geraldine Farrar’s loveliest rôles.
Tosca, in which Farrar, Caruso and Scotti made a famous trio, is a
blood curdling drama of murder, cruelty and love, full of music
which mirrors the story. The libretto was taken from Victorien
Sardou’s La Tosca, a celebrated drama in which the “divine Sarah”
(Bernhardt) made one of her most brilliant successes.
He uses interesting little musical devices which make it easy to
recognize a Puccini piece, and his music has charm. It is built on
Italian tradition but is distinctly of the 19th century. He enjoyed the
greatest popularity of his day, and there have been few, excepting
perhaps Verdi and Wagner, whose operas have been so well known.
His beautiful melody, piquant airs, fine rhythms, clever orchestration
and humanness of plot, make Puccini very often touch the edge of
opéra comique. Although he uses a musical phrase over and over
again, it is not like the Wagner leit-motif. There are no concerted
finales or clearly defined stopping places as there used to be in
earlier operas. So you see, Puccini profited by Wagner and Verdi.
His Girl of the Golden West, a California story of the days of ’49,
had its world première (first production) at the Metropolitan Opera
House (1910). For some time Puccini had been looking for a libretto
for a new opera. While in New York, to be present at the
Metropolitan production of Madame Butterfly, he was also
searching for material in the hope of finding an American story.
Again David Belasco came to his aid. His own Girl of the Golden
West, a picturesque play, was being given and he invited Puccini to
see it. He was interested and turned it into an opera. The rehearsals
at the Metropolitan were most interesting with Puccini and Belasco
working together. Emmy Destinn and Caruso sang the leading rôles.
It is realistic, dramatic, beautiful in parts, and not written for
coloratura exhibitions! But when it was produced it proved too
Italian for Americans and too American for the Italians, so Puccini
was disappointed in its lack of success.
Puccini’s operas, as well as Verdi’s and others, have a new
popularity, that of the mechanical player audience, the gramophone
and playerpiano.
 Wolf-Ferrari and “The Jewels of the Madonna”

One of the most delightfully witty opera writers is Ermanno Wolf-

Ferrari (1876), son of a German father and Italian mother, and writer
of The Secret of Suzanne (her secret was that she smoked!) a very
droll and amusing story. He is musical grandchild to Mozart, so
delicately does he sketch and so charming is his melody. If you hear
his operas, including the tragic and exciting but beautiful The Jewels
of the Madonna, you will certainly say that he can make more out of
a little, than almost anyone. With a small orchestra he seems to work
miracles, and his melodies are gracious and his rhythms captivating.
 Montemezzi Visits America

Whether it was Lucrezia Bori (Spanish soprano) or Montemezzi

who made L’Amore dei Tre Re (The Love of Three Kings) so
entrancing, is hard to say. Here is lovely music flowing on endlessly!
It is rich and deep; the voice is handled delightfully, and the
orchestration is masterly and beautiful throughout. The Love of
Three Kings is real music drama and few other operas have so fine a
libretto.
Montemezzi with his American wife paid a visit to America (1925)
and was fittingly received at the Metropolitan Opera House where
Edward Johnson and Lucrezia Bori delighted people with the lovely
opera.
Some of the other modern names in Italy are Giovanni Sgambati
(instrumental pieces); Giuseppi Martucci (instrumental pieces);
Marco Enrico Bossi, a famous Italian organist whose visit to this
country in 1925 ended tragically, as he died on the boat on his way
home, and Buongiorno, Eugenio di Parani and Franchetti, and
Amilcare Ponchielli (1834–1886), composer of La Giaconda.
Now let us turn to what France has done in opera in the second
half of the 19th century.
 French Opera

When Meyerbeer was musical czar of Paris, we see not only

Wagner in France, but six other important composers. Hector
Berlioz (1803–1869) was a tone poet; Charles Ambroise Thomas
(1811–1896), Charles François Gounod (1818–1893), and Georges
Bizet (1838–1875) were opera writers; Charles Camille Saint-Saëus
(1835–1921) was a composer of concertos, piano and chamber music
and of one famous opera; and César Franck the Belgian (1822–1890)
who lived in Paris, although not an opera writer, influenced the
composers of opera who lived after him.
Mignon came from the heart of one of these, Ambroise Thomas,
winner of the Prix de Rome, and in 1871 the director of the Paris
Conservatory. He wrote several works, among them a successful
opera Hamlet, yet none have done as much for his reputation as
Mignon.
Félicien David (1810–1876) is known for his symphonic poem Le
Desert and his Laila Rookh, an opera which was given at the Opéra
Comique.
Another well known name is Benjamin Godard (1849–1895). Do
you remember the Berceuse from his opera Jocelyn? He wrote Le
Dante and La Vivandière and many salon pieces for young students
of the piano.
 Gounod’s “Faust”

Faust, in connection with music, makes us think of Gounod.

Gounod was born in Paris and showed musical ability when a boy.
He was graduated from the Conservatory and won the Prix de Rome
(1837).
His interest always seemed to be in religious music for he went to
Italy to study Palestrina and Bach. His study resembled a church for
it had stained glass windows and an organ, and furnishings which
gave it a religious atmosphere. After he returned from Rome he
studied for the priesthood but soon gave it up.
Gounod’s musical training was very broad for at first he was
influenced by Rossini, Weber and Mozart, and later by Bach and
Palestrina.
His Messe Solennelle (Solemn Mass) was given in 1861 and his
Faust in 1859. This is considered to be one of the most tuneful
operas written in the 19th century, and packs opera houses all over
the world. His Romeo and Juliette, though not as popular is still
given and his Médecin Malgré Lui (Doctor in Spite of Himself) (from
Molière’s play), “is a gem of refined setting” says Clarence Hamilton.
Among his other operas are Philemon and Baucis, La Reine de
Saba (The Queen of Sheba) both inferior to Faust.
During the Franco-Prussian war he lived in London where he
produced his oratorios The Redemption and Mors et Vita (Death
and Life) with his Gounod Choir, and held in England a somewhat
similar place to Handel and Mendelssohn, for he, too, had many
disciples.
He was a master of beautiful melody and instrumentation.
There is a new school in Paris whose slogan is, “Back to Gounod”
in order to recapture his way of writing melody!
 Everybody Loves “Carmen”

In Georges Bizet we see a man of genius who produced but one

great work. To be sure he lived only thirty-seven years, two years
longer than Mozart with his hundreds of pieces, yet Bizet is of great
importance in French opera and is looked upon by musicians as a
man of rare power, and he is loved by everyone for his marvelous
Carmen. Louis Gruenberg, the American composer, said, “I have
looked in vain for a flaw in Carmen but it is perfection throughout. It
is the one opera in the world that wins both musicians and the
masses alike, and it disarms criticism.”
Emma Calvé will always be remembered as Carmen, for she not
only sang the part with its intense melody and Spanish color, but she
lived it on the stage.
Bizet is an amazing orchestral tone painter, and one of the greatest
of all opera writers.
The story of Carmen is taken from a novel of Prosper Mérimée and
is full of the sun, the shadows, the fascinating dances, the bull fight
and the romance which belong particularly to Spain. Carmen is an
opéra comique, for in the original version as played in Paris it has
spoken dialogue.
His other things full of charm are Jeux d’enfants, four-hand pieces,
the Arlesienne Suite (dances) so pictureful and emotional. It is used
as ballet sometimes for Carmen.
Bizet was not appreciated and at first Carmen was a failure, but
many geniuses ahead of their time have shared the same fate.
After a painting by
Giacometti.

Georges Bizet.
Vincent d’Indy.

Camille Saint-Saëns.
 Jules Massenet.

Gustave Charpentier.

French Composers of the 19th Century.

It seems quite reasonable that after all the experiences France has
been through in the early and middle 19th century she should now
blossom out, not with remodelled Italian opera, but with her own
opera and her own ways of writing music.
The two influences were without doubt from César Franck and
Bizet whose sincerity not only influenced musicians but rather
quickly gained the public. The third influence was of course, Wagner,
who, though he infuriated many, gained followers for his theories
everywhere that his music was heard. In France, Reyer and Chabrier
were both Wagner enthusiasts and did much to bring him finally into
the Paris Opera House a little before the 20th century (adapted from
The Art of Music). Out of these influences came a fine group of gifted
composers,—d’Indy, Dukas, Charpentier and others.
Ernest Reyer (1823–1909), who was an ardent follower of Wagner,
had a hard time because of the new harmonies he used. His last
opera Salammbo is better known to us than the others, and his
works are still played in Paris at the Grand Opera.
A man famous as composer of the tone poem, España, Emmanuel
Chabrier (1841–1894) must come in here, for at the time of his death
he was writing a most interesting opera, Briseis, which was finished
by his pupils. The day before he died Robert Louis Stevenson
stopped in the middle of a sentence, in his novel The Weir of
Hermiston, one of his best. The first woman to receive the Prix de
Rome in France, Lili Boulanger (1892–1918) did much of her
composing in bed during her last illness; her devoted sister Nadia, a
prominent musician in Paris, and had received the second Prix de
Rome, finished the deathbed works. And did we not see Mozart
finishing his Requiem on the last day of his life? Illness and
impending death seem not to matter to men and women who have
genius.
This group was striking out for something new, and was influenced
by Wagner’s theories, Franck’s return to the old classic style, the
Russian school, the re-action against Wagner and the renewed
interest in orchestral concerts in Paris (adapted from C. G.
Hamilton).
 Saint-Saëns—the Child Prodigy and Octogenarian

Camille Saint-Saëns (1835–1921) wrote in all styles from classic to

the newest of program music. He is another who gave concerts
before he was twelve years old; he studied at the Conservatory, lived
in Paris as a composer, organist and pianist, was a learned man and a
very good musical critic. Later in life he lived in Algiers, which
accounts for the oriental touch in his music. He journeyed over much
of the world and we heard him in Carnegie Hall, on his last trip to
this country in 1915, on his way to the San Francisco exposition
where he played the organ and conducted his opera Samson and
Delilah. He played some of his most technically difficult pieces when
he was in his eighties. He wrote some symphonies, some descriptive
symphonic poems, Le Rouet D’Omphale, Phæton, Dance Macabre
(very weird and rhythmic) and others. Out of five, his G minor is the
most brilliant piano concerto.
He is best known for his opera Samson and Delilah which is
carried into fame by the two arias, My Heart at Thy Sweet Voice and
Love Come to My Aid. This last is of the finest lyric writing in French
opera and the first is surpassingly emotional. The choral parts (often
sounding like early Hebrew music) show a real master at work, and
the effect of the whole is very dramatic, whether sung as oratorio or
opera.
It is not as an opera writer, however, that Saint-Saëns wished to go
down to history for he threw his whole strength into trying to make
the French public know and love the classics. Paul Landormy says:
“From the historic point of view, Saint-Saëns is a notable figure.
Saint-Saëns is the French Mendelssohn.... He undertook the musical
education of France at the exact moment when Berlioz despaired of
succeeding with the task, and he prepared the public for the great
French School of symphonists which arose toward the end of the
19th century.”
In 1871 Saint-Saëns was made president of the newly formed
National Society of Music of which you will read later.
The ballet was used to advantage by Clement Philibert Léo Délibes
(1836–1891) a master of this form of music and dance. He built up a
certain atmosphere that is particularly French. His ballets, Coppelia
and Sylvia and his opera Lakmé are conventional and very popular.
Lakmé is opéra comique because of the spoken words and of its
romantic character. Délibes always has a certain delicacy of color,
and charm which captivates.
Another composer who writes in an exotic vein (or an out-of-the-
nation-to-which-he-belongs way, with all the color of the other
nation in costumes and scenes) is Edouard Victor Antoine Lalo
(1823–1892). Lalo was trained to sincerity by his models, Beethoven,
Schubert and Schumann. This does not mean copying, for his music
is not anything like the music of these men. He skilfully drew a
variety of effects from his orchestration, and his music has
individuality. His best known work in opera is Le Roi d’Ys. He also
wrote a work for violin and orchestra Symphonie Espagnole which is
a pet of all the violinists because of its brilliancy and beauty.
 Massenet

Jules Massenet (1842–1912) was something like a modern French

Meyerbeer and an Offenbach combined, yet his work is far more
worth while. Before he died he was at the height of his popularity in
Europe and America, and the repertory of the Hammerstein Opera in
New York included many of Massenet’s works. He composed operas
so rapidly that his public could not forget him!
He built on Gounod and Ambroise Thomas and gained much from
Wagner. He used continuous melody and some of the principles of
the leit-motif. Wagner’s music compared to Massenet’s was thick for
Massenet’s is thin!
Whether Massenet will always remain popular is a question. His
operas are engaging and clever, and he knew how to write theatre
music to please the public. The most important of his operas (about
fifteen), are Manon and Le Jongleur de Notre Dame. The title parts
of both were sung by the brilliant Mary Garden, in this country. (See
Chapter VIII.) Manon ranks second to the Jongleur. You know, too,
the Meditation from Thäis, another of his popular successes. It was
written for Sybil Sanderson, an American singer, in Paris. Massenet’s
operas did not show his tremendous knowledge of counterpoint, of
which he was professor at the Conservatory. His position was later
filled by André Gédalge who has taught most of the composers of
today. Gédalge is also the composer of some very fine symphonies,
sonatas and an extraordinary Treatise on the Fugue.
Other writers of this period are Xavier Leroux (1863–1919),
Gabriel Pierné, born the same year, composer of a delightful
oratorio, Children’s Crusade. He is now conductor of the Colonne
Orchestra in Paris. André Messager, born ten years before these two
is the composer of some very charming light operas of which
Veronique is the best known. There are also the great organists
Charles Marie Widor (1845) with ten organ symphonies and many
other works, and Alexandre Guilmant (1837–1911), a great organist
who came to America while one of the writers of this book (Ethel
Peyser) was at Vassar College, where he inaugurated the new organ.
 Followers of César Franck

Although César Franck was not a successful opera writer, he

influenced composers by showing how to combine modern harmony
successfully with the classic form.
Among the many César Franck’s revival of the classic style
influenced are Gabriel Pierné, Henri Duparc (1848), and Ernest
Chausson (1855–1899), Franck’s pupils. Chausson was first known
through Helen, a three-act opera and Le Roi Arthus, which show
what he might have accomplished had not an accident caused his
death. Besides the operas he wrote beautiful chamber music,
orchestral works and songs. His Poem for violin is full of gentle, yet
deep feeling. All his work has veiled mystery and is very lovely.
The most important pupil of César Franck is Vincent d’Indy (1851),
one of the most important figures in France. He founded, with
Charles Bordes and Guilmant, the organist, the Schola Cantorum,
and revived interest in sacred music. He has been in this country and
is admired for his symphonic works, his operas Fervaal and
L’Étranger (The Stranger), piano pieces and chamber music. One of
his symphonic poems, Istar, was made into a ballet for Mme. Ida
Rubenstein and was performed for the first time at the Grand Opera
in Paris, in 1924.
Alfred Bruneau (1857) links the Wagner period with Debussy’s.
His operas are rarely given outside of Paris. His manner was new and
caused much discussion. He based many of his plots on Émile Zola’s
writings, and was conductor of the Opéra Comique. The Attack on
the Mill was given in America.
 Charpentier’s “Louise”

Gustav Charpentier (1869) comes next. He made his name with

the delightful opera about the dressmaker apprentice Louise, a
musical novel on the life in Montmartre, one of the artist quarters of
Paris. Charpentier wrote the book, which was the story of his own
life. He also wrote its sequel Julien. No one who has ever been in
Paris fails to be deeply stirred by this picture of the simple home life
of the midinette or sewing girl. Mary Garden created the part of
Louise in America and it was the first rôle of her operatic career. In
one scene, you hear the almost forgotten street cries of Paris. He has
also written a charming work for orchestra, Impressions of Italy,
which is the result of his having won the Prix de Rome in his youth.
This brings us up to the 20th century to which we shall devote an
entire chapter. But in order to finish our story of French opera, we
will merely introduce you to Claude Achille Debussy, the ultra-
modern harmonist and weaver of mystery and beauty, who ushered
in the 20th century with his lovely and enchanting opera, Pelleas and
Melisande written on the play by Maurice Maeterlinck. For ten years
the composer worked over this masterpiece, and it was produced for
the first time at the Opéra Comique, in Paris in 1902. Here we find
something that never had been before,—opera completely separated
from all the old ideas of what opera should be. But in tearing down
the old, Debussy gave something very rare, beautiful, sensitive,
touching a very high artistic peak, in its place. This was pure
impressionism in music, just what romanticism was to the early 19th
century. This carries the French School to its highest degree of
mystic beauty.
Coming later than Debussy’s opera are Maurice Ravel’s L’Heure
Espagnole (The Spanish Hour), Henri Rabaud’s Marouf, Paul
Dukas’ Ariane et Barbe Bleue, also a Maeterlinck libretto and second
only to Pelleas and Melisande in atmospheric charm, Albert
Roussel’s Padmavati, an Oriental opera, that has been produced very
recently at the Grand Opera in Paris, and Florent Schmitt’s Le Petit
Elfe Ferme l’Oeil (The little elf winks its eye) presented at the Opéra
Comique in 1924.