The Exchange Fund achieved investment income of HK$103.7 billion in 2006.
It is once again the time of year when we announce the investment results of the Exchange Fund for the year that has just ended. This year, I am pleased to be able to report that the Fund earned an investment return of HK$103.7 billion in 2006, a rate of return of 9.5%: the second highest absolute figure and the fifth highest rate of return since 1994. After interest and other expenses, the net investment income was HK$93.5 billion and the Fiscal Reserves deposited with the Fund by the Government will receive a share of HK$28.9 billion, well above the figure of HK$18.2 billion included by the Financial Secretary in his budget. The assets of the Exchange Fund stood at HK$1,176.7 billion at the end of the year, up from HK$1,066.8 billion a year earlier.
Of course it is always nice to be able to deliver good news, and I believe this is a good result for the people of Hong Kong. The investment return of 9.5% was 63 basis points above that for the benchmark portfolio determined for the Fund by the Financial Secretary on the advice of the Exchange Fund Advisory Committee. As I have said before, this difference between the actual return and that of the benchmark – the alpha as it is known in the investment business – is a more appropriate measure of the HKMA's performance in managing the Exchange Fund: more so than the absolute figure as it reflects the results of our active management of the Fund. An alpha of 63 basis points is a good result when compared with recent years. It is equivalent to HK$6.6 billion, or almost 10 times the HKMA's administrative expenditure in 2006.
But regular readers of this column will know that I am a cautious man. Nice as it is to announce a good figure, I and my colleagues at the HKMA will not let it go to our heads. I have pointed out many times that, although the Exchange Fund has to be invested, it is not an investment fund and investment is not its primary purpose. The purposes of the Fund are clearly set out in the Exchange Fund Ordinance: to affect the exchange value of the currency of Hong Kong and to maintain the stability and integrity of our monetary and financial systems. Those purposes mean that we take a prudent approach to investment, focusing on capital preservation and liquidity rather than return, and that approach will continue. Indeed the global economic environment calls for caution: financial markets were volatile in 2006 and that volatility looks set to continue. The bond markets benefited from an expectation of a slowdown in growth in the US, while the equity markets experienced a rally in the latter part of the year because of positive earnings figures and mergers and acquisitions. In Hong Kong, record IPOs brought the stock market to new highs. The bond and equity markets do not always move together in this way; indeed we spread investments across both sectors precisely to manage the risk that they will not.
Three weeks ago I wrote about the outlook for 2007 and mentioned two factors that were likely to affect the economy of Hong Kong: the global imbalance and the Mainland authorities' efforts to cool the economy. Other factors will also affect the global investment environment: the rise in equities markets that we benefited from in 2006 makes the prospects for those markets in 2007 more uncertain; the buoyancy we have seen in the global economy and high levels of liquidity have led to volatility in asset markets that is likely to continue; uncertainties in the global economy, especially in the outlook for inflation in the US and other major economies, make it hard to foresee the policy stance of central banks and trends in interest rates. And of course there is always geo-political risk, especially in the Middle East and closer to home in our own region. All of these are likely to make things even more challenging in 2007 than they were in 2006, and it would be very difficult for the Exchange Fund to achieve the same results this year.
So, although we have allowed ourselves a modest celebration, we at the HKMA, guided by the wise counsel of the Exchange Fund Advisory Committee and its Investment Sub-Committee, are not resting on our laurels. The work of managing the Exchange Fund is continuous, and the end of the year is really just another day, albeit one on which we take stock of progress. We will, as always, be working hard to manage the Fund prudently and as successfully as we can, given its statutory purposes.
Joseph Yam
18 January 2007
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