In 2018, Finansiel Stabilitet introduced an active investment management approach for the Resolution Fund and the Deposit Guarantee Fund. The reason for choosing a more active strategy was that Finansiel Stabilitet was no longer able to place cash deposits with Danmarks Nationalbank at 0% interest. This option ceased in 2017, and against this background, explorations were conducted with the Danish Ministry of Industry, Business and Financial Affairs as owner of Finansiel Stabilitet and with the institutions that have an obligation to pay contributions to discuss potential investment strategies, risk profiles and scenarios. In addition, the institutions that have an obligation to pay contributions were informed that a more active strategy could potentially produce a better return, but would also involve a higher risk of loss. As a result, in the event of a realisation of losses on the portfolio invested, the institutions could be required to make additional contributions to the Resolution Fund and the Deposit Guarantee Fund.

The investment strategy was based on a choice of risk profile including a fixed liquidity, interest rate and credit risk profile. The purpose was for the assets held in the funds over time to generate a return above Danmarks Nationalbank’s CD rate, but at the same time to maintain a strict focus on liquidity to ensure that the funds could be made available in the event of financial crises. In this connection, it is emphasised that the Resolution Fund and the Deposit Guarantee Fund are bound by a requirement that investments must be made in low-risk securities.

Low-risk assets are defined as securities considered by the Danish Financial Supervisory Authority to be safe and liquid as well, including government bonds issued in the EU, Danish mortgage bonds, covered bonds issued by mortgage credit institutions, covered bonds, covered bonds issued outside Denmark, senior debt in credit institutions with a rating of at least BBB/baa, other issues with a rating of at least BBB/baa, etc.

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Against this background, in the period from start-2018 to mid-2020, investments were made in short-term fixed-rate mortgage bonds without a conversion option and with an interest rate risk measured at a duration of 2.5 years. Investments were generally made in tranches of DKK 1.6 billion on average. Against this background, the total liquid funds held in the Deposit Guarantee Fund were invested, and the funds held in the Resolution Fund were invested on an ongoing basis as and when contributions were claimed from the sector.

The more active investment strategy was characterised by not being tied to certain interest rate expectations, but rather based on the possibility of achieving an excess return further out the yield curve. At the same time, the intention was for the investment strategy to have a long-term perspective, meaning that short-term fluctuations would not lead to any significant adjustments to the strategy.

However, when contributions to the Resolution Fund were collected in 2020, the excess return on an investment in short-term mortgage bonds compared with the extra interest rate risk assumed was so low (the interest rate difference between the CD rate and a 2.5-year mortgage bond was very small) that it was no longer considered advantageous to make additional investments in the low-interest rate scenario. Against this background, additional contributions made to the Resolution Fund were placed as cash deposits in the following years.

Accordingly, at 31 December 2022, the amount invested by the Resolution Fund and the Deposit Guarantee Fund in short-term mortgage bonds totalled DKK 10.2 billion. Furthermore, the two funds had placed DKK 3.7 billion as cash deposits with Danmarks Nationalbank, see figure 1.

Note: Compared with a 3-year benchmark from Nykredit, the mortgage bond portfolio of the Deposit Guarantee Fund and the Resolution Fund generated a comparable risk-adjusted return.

As mentioned above, the more active strategy was not driven by short-term interest rate expectations. Regardless of the fact that the investment strategy is based on a long-term perspective, the assessment in retrospect is that, until the end of 2021, the active investment strategy in short-term mortgage bonds was an attractive alternative to placing cash at Danmarks Nationalbank’s CD rate, see figure 2. Even during the major fluctuations in fixed-income markets after the COVID-19 crisis in March 2020, the investment in short-term mortgage bonds continued to generate a positive return.

In 2022, the surge in interest rates contributed to changing the scenario as it stands today. In particular in Q1-Q3 2022, the unrealised capital losses in managed mortgage credit mandates were adversely affected by a surge in government and mortgage bond yields. This development was driven by a significant increase in European and US inflation numbers, which prompted central banks to hike monetary policy rates considerably. As a consequence of interest rate increases in 2022, the return was negative at 6.8% from 1 January to 31 December 2022 compared with a return achievable by placing cash at Danmarks Nationalbank’s CD rate, which would have been negative by about 2.3%. Taking into account cash placements of DKK 3.7 billion, the Deposit Guarantee Fund and the Resolution Fund posted negative returns of 6.9% and 3.4%, respectively, in 2022.