Review of IFAD’s Investment Policy 16 March 2011

2 IFAD’s Investment Objectives Investment goals: Preservation of Capital Ensure Liquidity Minimize Risk To achieve these goals, the Fund invests primarily in highly rated fixed income securities (bonds) Expected return on portfolio of 3.5% reviewed by the World Bank in Minimum Liquidity Requirement approved by Executive Board in 2006 and reviewed in 2010; remains unchanged at 60% of total annual gross disbursements (cash outflows) and potential additional requirements due to liquidity shocks. “The President may place or invest cash funds, not needed immediately for the Fund’s operations or administrative expenditures. In investing the resources of the Fund the President shall be guided by the paramount considerations of security and liquidity. Within these constraints the President shall seek the highest possible return in a non- speculative manner. Income earned from investments may, inter alia, be used by the Fund to meet its administrative and other expenditures in accordance with the approved budget.” - Financial Regulation VIII

Evolution of Current Investment Policy Policy formed by a series of changes made since 2001 – but not consolidated in a single paper. IFAD’s Strategic Asset Allocation (SAA) based on weighting system; the weights have not changed substantially in ten years. 1) IFAD completely divested from the global equities portfolio in March 2005 with proceeds funding the HTM portfolio. 2) HTM portfolio is fixed at US$400 million with its allocation redistributed among GGB and DFI portfolios (ratio 35:65 respectively) as these portfolios reflect the types of securities held in the HTM portfolio. 3) HTM Investment Guidelines (IG) stipulate credit ratings of AA- for Government and AAA for Corporate with a maximum exposure to 50 per cent of Corporates. 4) IFAD EB Report (Document EB 2001/74/R.4/Rev.1).

4 The current investment policy uses a “static” allocation approach. Asset ClassWeights Cash5.5% Diversified Fixed- income 15.2% Global government bonds 43.5% Inflation-indexed bonds 20.0% Hold-to-maturity*15.8% Total100.0% The composition of assets in the portfolio is held relatively constant. Investment Policy SAAActual Portfolio (Dec 2010) *Hold-to-maturity is fixed at a face value of $400 million.

5 This approach worked well in certain years, but is now coming under pressure. The current policy peaked in 2007/2008. The Fund’s investment goals have been achieved for the last five years. However, the trend is downward, and – if unchanged – negative performance is foreseen over the near term.

Outlook for Fixed Income Market 6 The outlook for fixed income is negative: - Interest rates are at record lows - Energy and food prices rising - Inflation rising - Need for monetary policy to contain inflation Since late 2010 yield curves have been rising, adversely affecting the portfolio over the last 3 months

7 The current static allocation has a high risk of performing negatively over the short-term. 1 year3 years Expected return % Prob. Negative return %* ORTEC Simulation Under the current “static” allocation approach, there is a high risk that IFAD’s portfolio will see a negative return in 2011 Actual Portfolio (Dec. 2010) Diversified fixed interest bonds 17.6%

8 Tactical response to market changes ORTEC Simulation 1 year3 years Expected return % Prob. Negative return %* Best available option for IFAD in the short-term… ….but not sufficient to off-set inflation. 1 year3 years Expected return % (real)** **Indicative only. assumes average inflation of 2.5% in each period. IFAD will likely increase its cash allocation over the short-term in response to the market.

Improve risk management Current Approach 1.Monthly Value-at-Risk (VaR) reporting 2.Discretionary investment/divestment decisions based on risk monitoring 3.Nominal Returns 4.FX Alignment (currently performed by all external managers) 9 Rationale 1.Improve risk monitoring to expedite investment decision-making 2.Build a framework to contain losses and minimize discretionary decision-making 3.Consider inflationary effects on the Fund’s assets and liabilities 4.Flexible and efficient currency risk management Enhanced Approach 1.Use measures (CVaR, VaR, probability of negative return) as tools for managing risk 2.Implement Stop Loss Policy 3.Include real returns as a reference indicator 4. FX Alignment (performed by a single currency overlay manager)

10 Revisit the Investment Policy 1.Maintain status quo and accept high risk of capital loss over the next three years 2.Develop a new Investment Policy to lower risk of negative returns and preserve capital base a)Increased diversification of assets b)Allow greater flexibility in asset allocation weights for improved risk management Options:

11 Diversification and flexibility in the context of IFAD’s portfolio Source: ORTEC 5. +Emerging Markets (A) 1. Gov‘t bonds (AAA) 3. +Corporates (AA+ to A-) 6. +Emerging Markets (A to BB) 2. +Corporates (AAA) Probability of a negative return (%) Average portfolio return (%) over three years 4. +Inflation- indexed bonds 7. +Cash 8. +HTM and ABS Manage risk by introducing greater flexibility and diversification (within fixed-income)

12 How would IFAD diversify? Including additional investment grade securities will contribute to reducing the high concentration risk in IFAD’s portfolio. AAA AA+ AA AA- A+ A A- Current approach Sovereign Ratings Eligible Issuers Developed markets Proposed approach AAA AA+ AA AA- A+ A A- BBB+ BBB BBB- Countries with eligible ratings and strong fundamentals Eligible Issuers Sovereign Ratings Highly correlated assets Less correlated with Developed markets Expand issuer universe Current policy floor Legacy HTM and countries with multiple ratings 2. Corporate floor of A- 3. No “junk bonds” 1. Sovereign floor of BBB- 4. Only strong macro fundamentals 5. Only SDR-linked currencies

13 How would IFAD achieve greater flexibility in asset allocation? Asset ClassWeights Cash5.5% Diversified Fixed- income Sovereigns Corporates Asset-backed securities 15.2% Global gov’ t bonds (developed countries only) 43.5% Inflation-indexed bonds 20.0% Hold-to-maturity*15.8% Total100.0% Current Approach *Hold-to-maturity is fixed at a face value of $400 million. Proposed Approach Asset Class Cash Global gov’t bonds (including emerging markets) Corporate bonds (with potential for increased allocation) Asset-backed securities Inflation-indexed bonds Hold-to-maturity 2. Abandon static asset allocation system 3. Manage/adjust allocation by constantly monitoring and mitigating risks 1. Redefine eligible asset classes

14 Comparison with other IFIs Proposed Approach Cash Corporate bonds Asset-backed securities Global gov’t bonds (including emerging markets) Inflation-indexed bonds Hold-to-Maturity Other IFIs’ Approach All IBRD, ADF, ADB, FSO, IaDB, AfDB, AfDF include Corporates as an asset class in their investment policies. As of 2009, AfDF and AfDB invested 20% of portfolio in Corporates IBRD, ADF, ADB, FSO, IaDB, AfDB, AfDF ADF and ADB invest in member countries, regardless of rating. AfDF invests in emerging market local currency issues. For IBRD – no rating is required if issue is in local currency. Assumed that all hold these as a component of global government bonds, as they are considered “risk-free”. ADB, IaDB, AfDB, AfDF Other asset classes which IFAD is not considering: Equities: IBRD, ADF, ADB and IaDB Repurchase agreements and Securities Lending: IBRD, IaDB, AfDB

Implementation Plan 15 Develop a “risk budget” framework for IFAD; identify key risk measures (e.g. VaR, CVaR, probability of negative return) and their respective tolerance levels Collaborate with an external provider to customize the risk measures to best suit the needs of the institution Work with an external provider to: 1.Monitor IFAD’s asset allocation as needed, based on latest market information/developments 2.Adjust the portfolio as necessary to ensure the tolerance level for each risk measure is not breached Report quarterly on implementation progress of the above to the Executive Board

Conclusion 16 The over-riding objective is to preserve IFAD’s capital Ensure non-speculative investment income for internal resource generation However, the current SAA will not realize these goals Therefore, IFAD should introduce a new approach: Increase diversification (emerging market debt and increased allocation to corporates as necessary) Static to Dynamic Asset Allocation Adjust asset allocations as needed to best manage risk Enhanced risk management framework must also be implemented

Thank you for your attention