The Exchange Fund Half-Year Results

inSight

29 Jul 2004

The Exchange Fund Half-Year Results

During a very volatile first half of 2004 the Exchange Fund achieved a positive investment return.

Readers probably can recall what I said in my briefing on 3 May this year to the Legislative Council Financial Affairs Panel concerning the very sharp fluctuations in the investment income of the Exchange Fund experienced in the first few months of the year. I said that the sharp volatility of financial markets this year had meant a very challenging investment environment. As illustration, I disclosed that the investment income of HK$16.8 billion achieved in the first quarter of 2004 had been reversed in April.

We have just released the numbers on the Exchange Fund at the end of June. As usual, we mark assets to their market value, in line with international best practice and in view of the liquidity requirements in support of the proper performance of the function of the Fund. They show an investment income of HK$9.6 billion for the first half of the year. Taken together with the information I disclosed earlier, it is clear that this amount was achieved largely in May and June of this year, when market conditions improved somewhat. And, once again, we see high volatility from month to month (indeed, July does not look very promising). The important thing, given the objectives of the Exchange Fund, is to focus on the medium and long-term returns and not on the sharp, short-term fluctuations in the figures. I am sure those with investments that have similar long-term objectives will readily appreciate this.

Readers will find in our usual press release a breakdown of the figures on investment income for the first half of the year. The investment income from bonds (total return of HK$6.3 billion) and foreign equities (HK$5.7 billion) has been partly offset by losses in Hong Kong equities (HK$0.4 billion) and in foreign exchange (HK$2 billion). In the first half of the year, the price of Hong Kong equities, as measured by the Hang Seng Index, fell by 2.3% (adjusted for dividends received the index in fact fell by only 0.3%). As we have committed ourselves to holding our current Hong Kong equities portfolio on a long-term basis, there was no scope for varying the Exchange Fund's exposure to Hong Kong equities so as to improve the overall investment performance of the Exchange Fund.

Concerning the exchange gains or losses, it should be emphasised that these do not arise from the taking of speculative foreign exchange positions, as a few commentators would have readers believe. The desire to achieve a better return and to manage the associated risks is best satisfied by some limited diversification into foreign currencies other than the US dollar. When the US dollar strengthens, as it did in the first half of the year, the investment strategy incurs some exchange losses.

The second half of the year will continue to present tough challenges on the investment front. The pace at which US interest rates move back to "normal" is unclear and therefore the US bond market will be volatile. The macro-economic adjustments taking place in Mainland China will continue to affect short-term market sentiment, particularly that of the Hong Kong equity market. The global imbalances, and specifically the large current account deficit of the US, continue to threaten sharp and possibly destabilising adjustments in financial markets. The probability of the occurrence of unpredictable events is also likely to be higher than usual, given that it is an election year, and geo-political tensions persist. It's tough, but we will be on the alert and shall continue to do our very best.

 

Joseph Yam

29 July 2004

 

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Last revision date : 29 July 2004