Despite losses on Hong Kong equities and the euro, Hong Kong's Exchange Fund showed a modest profit in 2000, thanks mainly to strong performance in the US bond market.
Two weeks ago I offered a preview in this column of the likely investment performance of the Exchange Fund for the year 2000. We now have some concrete -though preliminary - figures on this subject to share with our readers.
With the net fall recorded in the Hang Seng Index for the year, we have, as expected, lost money on the Hong Kong equity portfolio. Marked to market, the loss amounted to $11.6 billion. Given the high volatility of the stock market, the investment performance of the Exchange Fund will inevitably be affected, for as long as the size of that portfolio relative to the size of the Fund as a whole remains substantial. During the year, however, we did manage to dispose of $46.6 billion of Hong Kong stocks through the well-established mechanism of the Tap Facility of the Tracker Fund, without any noticeable effect on the market. But at the end of last year, we still had $150.7 billion in Hong Kong stocks. Our intention is to keep only around $50 billion, which is the extent of volatility that we feel the Exchange Fund should comfortably assume. No doubt Exchange Fund Investment Limited will continue skilfully to manage the disposal of the excess, valued currently at around $100 billion, just as it has done with the $90 billion sold so far.
Notwithstanding the late rally at the end of last year, the exchange rate of the euro against the US dollar, and hence against the Hong Kong dollar -the accounting currency for our Exchange Fund -experienced a net depreciation of 8% for the year. The yen also weakened significantly during the year. In investing the Exchange Fund, we do, as part of a prudent long-term strategy, diversify into foreign currencies other than the US dollar. Our investment benchmark, as determined by the Exchange Fund Advisory Committee, for the euro is 15%, and for the yen is 5%. In practice, we are allowed to deviate modestly from those benchmarks in order to maximise the benefit or minimise the loss arising from short-term market movements, such as those we saw in the year 2000. But it is inevitable that when the US dollar is strong our investments in other foreign currencies will suffer, and vice versa. The exchange loss, mainly in the euro and the yen, amounted to $11.2 billion for the year.
But we have done very well in the bond market, strategically positioning ourselves, along the yield curve of US Treasuries, to limit the adverse effect of the interest rate hikes in the first half of the year and to benefit from the favourable conditions in the second half. We also benefited from the buyback of US Treasuries by the US government as its budget ran into surplus, and this buoyed bond prices. The interest income and the investment gains from this source, together with some dividends we received from equities, amounted to an impressive $67.4 billion. This more than offset the book loss incurred in Hong Kong equity and the exchange loss to produce an overall investment income for the Exchange Fund of $44.6 billion. Together with $0.2 billion from other income (mainly bank licence fee), total income amounted to $44.8 billion.
But there were the usual interest expenses to be accounted for, as quite a large part of the assets of the Exchange Fund represents borrowed money. There is, for example, a total of $109.3 billion of Exchange Fund paper issued to facilitate liquidity management of the banking system and to help the development of the local debt market. The Exchange Fund also borrows money from banks in its own liquidity management for the investment portfolio. Interest and other expenses amounted to $10.5 billion in the year 2000, and so net investment income amounted to $34.3 billion.
The fiscal reserves, of course, share in this net investment income, and in the volatility of it, on the basis of sharing arrangements effective from April 1998. Out of this $34.3 billion, $18.1 billion accrues to the fiscal reserves, leaving $16.2 billion to be added to the accumulated surplus of the Exchange Fund, representing an increase of a modest, but hard-earned, 5.6%. It should be noted, however, that it is still far too early to tell what the investment income for the fiscal reserves, and its implications for the budget, for the financial year 2000-2001 might be. There are still three months to go, and in present day financial markets, a lot can change in three months. At the end of November 2000, we were still looking at a loss, in the form of a fall in the accumulated surplus, for the Exchange Fund. Yet in a single month -December -all that was reversed.
It would be even harder, therefore, to discuss the investment outlook for the year 2001. In order not to disappoint readers, however, I should just say that the investment climate will continue to remain quite uncertain in 2001. The US interest rates have just been lowered, and may well be lowered again. A lot hinges upon how the US economy fares. But we shall continue to do our best in our management of this chunk of financial assets that belong to the people of Hong Kong.
Joseph Yam
11 January 2001
More information on the Exchange Fund can be found here.
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