My experience as a portfolio manager in a central bank
During my studies at ESSEC Business School, I had the chance to attend the SimTrade course. This course helped me to secure an internship as a risk manager at Bank Al-Maghrib (the central bank of Morocco) as I was asked during my interviews technical questions about financial markets that were covered during the course.
In this article, Youssef LOURAOUI (ESSEC Business School, Global Bachelor of Business Administration, 2020) shares his experience as an intern in the risk management department (middle office) at the Central Bank of Morocco (Bank Al-Maghrib) in 2020.
Bank Al-Maghrib
The central bank of Morocco was founded in 1959 after Morocco proclaimed its independence. It is a 100% state-owned bank that regulates the markets and the economy by implementing monetary and economic policies to ensure the welfare in terms of the parity of prices and the control of inflation. Inflation is a major economic indicator that possesses strategic importance and is part of the major focus for the central bank.
I describe below my experience at Bank Al-Maghrib.
My internship at Bank Al-Maghrib
I was affected at the middle office department, which is in charge of measuring risk exposures and profits and losses on the positions taken by the bank on an investment portfolio of 27,4 billion euros of foreign reserve. One of the key risk exposure metrics is volatility measured by the standard deviation statistically defined as the dispersion of a random variable (asset prices or returns in my case) from its expected value. The standard deviation indicates how much the current return is deviating from its expected historical returns. It is one of the most widely used metrics for investors when analyzing the risk of an investment. Among other key exposures metric, there is what it is called the VaR (Value at Risk) at 99% and a 95% confidence level for 1-day and 30-day positions. In other words, the VaR is a metric used to compute how much loss can the portfolio incur at a % degree of confidence for a given time horizon.
Every day, the Head of the Middle Office organizes a general meeting where he talks about global debriefing of the main financial news that happened overnight and debriefing the middle office desk for the “watch out” assets that could have a potential investment opportunity. Accordingly, the team has also the task of staying in line with the investment decision that characterizes the organization, as it does not operate as an investment banking corporation nor a hedge fund in the risk and leverage used. As the central bank has the special task of keeping safe the national reserve and searching for a good mix to invest in a low risk asset (AAA bonds from European countries coupled with American treasury bonds).
My task aimed to get a hand on the investment mechanism in the middle office of the bank. The investment mechanism consists of the division of the overall portfolio into three main tranches where each one has its characteristics. The first tranche (called also the security tranche) is calculated by analyzing the national need for a currency that needs to be kept safe to establish welfare on the exchange market (based mainly on short term position in low-risk profile asset (Liquid and high rated bonds). The second tranche is based on buy and hold and a market strategy. The first one consists of taking a long position on more risky assets than the first tranche till maturity, there is no selling during the lifetime of the asset (riskier bonds and gold). The second strategy is based on buying and selling liquid assets for an expectation of yielding higher returns.
During my time at the middle office desk, I’ve managed to develop a tool to represent the investment mechanism used for asset allocation. The tool, developed in an Excel spreadsheet, is an intuitive and simplified model that enables the understanding of the investment mechanism. Indeed, it is capable of continuously refreshing the data by importing the most recent quotations (from data providers like Bloomberg or Reuters as the two main financial data providers) to allow for an update of the different exposures and thus allow to respect the proportions of portfolio allocations. It has also a dynamic risk management tool to effectively compute draw-downs (a peak-to-trough decline during a specific period for an investment) and stressed conditions, as I experienced how the markets reacted to the novel Covid-19 pandemic with one of the most historic market movements in a long time.
Some of the key learning outcomes:
- The introduction to data analysis by manipulating large datasets
- Portfolio optimization based on the Markowitz efficient frontier
- Dynamic portfolio allocation based on the fundamentals of the modern portfolio theory
- The theory of efficient markets to understand how the markets evolve and move in a different direction as a reaction to events.
Front office, middle office and back office
My internship was also a good opportunity to discover the different departments of the bank: the front office, the middle office, and the back office:
- The front office directly deals with the individual or corporate clients of the bank. Salespeople propose adequate products and solutions to the clients (they are in front of them!). Traders intervene in the financial markets on behalf of the clients or for the bank itself (proprietary trading). To answer the demand of clients, financial engineers and quants also develop new products and the associated mathematical models to price them. One of the main trends that are emerging in the front office is the automatization with the help of AI and algorithmic trading that is taken some room in the trading desks. At this time the bank didn’t implement any technology based on high-frequency trading, but it is taking the financial industry by surprise and it goes a long way back, nearly decades ago since the first usage of algorithmic trading.
- The middle office situated between the front office and the back office (somewhere in the middle!) deals with the risk management of the bank. Risk managers control the traders’ positions (respect of constraints such as value-at-risk limits and stress tests) and compute the profits and losses (P&L) on traders’ positions daily.
- The back-office deals with the conformity and the security check of every trade to ensure a proper settlement.
Note that the frontiers between the front, middle, and back-office may change from one bank to another. And last but not the least, the IT people are also supporting all three departments to make the whole system work. In other words, they are in charge of the maintenance of the technical infrastructure that the bank uses daily to operate fluently, as all the departments are dependent on internal software to intermediate and operate in the market or to communicate between each department of the bank or with another organization. The IT desk has great importance in offering a flawless experience for the employees when using the internal electronic infrastructure. There is the backbone of the bank skeleton.
All in all, the SimTrade module served me well as I managed to gain quickly the necessary knowledge and bridge the gap that I had to be in the best position to achieve the missions I’ve been affected. I especially used the content of Period 2 of the SimTrade certificate, which deals with market information. The concepts of trading and investing were also obviously useful for the development of my portfolio management tools.
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▶ Akshit GUPTA Portfolio manager – Job description
▶ William ARRATA My experiences as Fixed Income portfolio manager then Asset Liability Manager at Banque de France
▶ Alexandre VERLET Classic brain teasers from real-life interviews
▶ Jayati WALIA Capital Asset Pricing Model (CAPM)
▶ Youssef LOURAOUI Markowitz Modern Portfolio Theory
Useful resources
About the author
The article was written in November 2020 by Youssef LOURAOUI (ESSEC Business School, Global Bachelor of Business Administration, 2020).