In an unfavourable investment environment, the Exchange Fund recorded an investment income of HK$38.1 billion in 2005.
Readers are aware of the very high degree of transparency with which the HKMA conducts its activities. This is particularly so for areas in which there is a high degree of community interest, and one such area is, of course, the investment management of the Exchange Fund. In contrast to the practice in the old days, when even the size of the Exchange Fund was kept secret, we now publish an abridged balance sheet for the Exchange Fund every month. This high frequency of disclosure facilitates close monitoring of this important area of activity by the many people in the community who have an interest in it. Indeed, we are talking about the management of a very large sum of money (over HK$1 trillion) belonging to the people of Hong Kong.
The preliminary figures for the Exchange Fund at the end of 2005 are now available. There are no surprises. As figures earlier in the year also showed, the investment environment has not been favourable, affected by the strengthening of the US dollar from its historical weak point (1.36 against the euro) at the end of 2004 and the successive increases in US interest rates. Perhaps a little comforting news for most investors in 2005 was the good performance of stock markets worldwide, with the exception of those in the US and Hong Kong. Thus, while there were significant gains arising from the Exchange Fund's equity and bond holdings, they were partly offset by losses arising from the holding of foreign currencies other than the US dollar.
There was considerable volatility in investment return during the year, reflecting, unavoidably given the large size of the Exchange Fund, volatility in the financial markets in which the Fund is invested. After incurring a small loss (HK$2.1 billion) in the first quarter of 2005, we managed to make considerable profits for the Fund in both the second (HK$13.6 billion) and third (HK$19.0 billion) quarters. But mixed market conditions in the fourth quarter meant that only limited gains (HK$7.6 billion) were achieved.
Total investment income of HK$38.1 billion for the year as a whole is, I think, respectable. I say that on the basis of the established method for measuring investment performance, which is to compare the actual rate of return with the rate of return of a benchmark portfolio, or the benchmark return. In 2005 we outperformed the benchmark return by about 0.2%, continuing our record of at least matching the benchmark return ever since the measurement method was adopted seven years ago in January 1999.
As I predicted several times during the year, the share of the investment income accruing to the fiscal reserves, at HK$10.0 billion, falls short of the projected amount included in the Government budget of HK$14.1 billion. As I have also explained on a number of occasions, the budget figure for the investment return on the fiscal reserves placed with the Exchange Fund is a trend figure and, as such, is not based on any scientific prediction of the likely financial market performance (which is itself an impossible task). In any one year the investment performance is likely to be very different from the budget, predominantly because of the volatility of financial markets, rather than our performance in investment management. In this connection, readers may wish to note that in four out of eight years the actual return was higher than the budget estimate, and averaging over the eight years the actual return is also higher than the budget estimate.
We continue to do our very best in the investment management of the Exchange Fund, as we do also in our other areas of responsibility. While monitoring closely our performance, readers should remember that the Exchange Fund is not an ordinary investment fund. It must be used for the clearly defined statutory purposes of affecting directly or indirectly the exchange value of the currency of Hong Kong (and other purposes incidental thereto) and maintaining the stability and the integrity of the monetary and financial systems of Hong Kong. These over-riding purposes constrain our ability to maximise the investment return on the Exchange Fund.
Joseph Yam
19 January 2006
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