At the beginning of the year when we announced the investment results of the Exchange Fund for 2009, we cautioned the community about the possibility that the path to the global economic recovery would not be smooth. We pointed out that the financial markets had barely recovered from the shock of 2008 and the real economy was still weak and feeble. The recovery, though visible, had not been supported by a strong rebound in employment.
The financial markets seemed to be moving ahead nicely at the turn of the year, carrying forward the strong momentum from 2009. But the Greece sovereign debt crisis in the second quarter and its contagion impact on other European countries brought this positive sentiment to an abrupt halt. Investors began to question the viability and sustainability of the euro system. As a result, euro-denominated debts were sold heavily and the euro plummeted.
Following the introduction of the European Stabilisation Mechanism in May, the markets calmed for a short while but quickly turned their attention to the long-term fiscal sustainability of the peripheral Euro-zone countries. Germany suggested that governments in the euro system should apply more discipline to solve their fiscal problems. The idea was well received by the participating nations of the G20 meeting held in Toronto in June. These austerity fiscal measures should rightly address investors' concerns about the long-term financial health of the European nations. However, the other side of the coin, the short-term pain that often comes with austerity measures, caught the market at the back foot. Investors were worried that the European governments might pre-maturely pull back their support for the economy, at a time when the recovery was still nascent, and push the global economy into a double-dip recession. Investors' risk appetite dwindled and they ran for shelter in safe-haven currencies and asset classes. Since April, the risk-aversive mentality snowballed into a strong and massive power affecting many asset classes. As a result, capital flooded to the US Treasury, which is usually perceived as a safe asset.
The sudden change in market sentiment had cost many investors dearly. There were newspapers reports saying some 350 Mandatory Provident Funds in Hong Kong had recorded an average investment loss of 4.8% in the first half of 2010. May 2010 was also one of the worst months in the history for hedge funds, despite the fact that they are supposed to be better equipped to weather market volatilities. It is therefore not surprising that, in such a difficult investment environment, the Exchange Fund's investments also took a hit. Fortunately, our conservative investment approach and a well-balanced investment mix have helped contain the damage.
We take a pragmatic approach to gauging the outlook for the market. Surely we hope that investor sentiments could improve and the investment environment could become more accommodating in the second half of the year. But current uncertainties in the market are such that it is hard to take this optimistic view. On the one hand, severe fiscal restraints will lead to a reduction in public expenditure, thereby affecting growth and recovery. On the other hand, if fiscal restraints were not introduced, some governments might find it too difficult to borrow to cover their expenditures. This is certainly not an easy situation, which has left the market highly uncertain about the growth outlook of the European and the global economy.
The current difficult investment environment will inevitably put some pressure on the Exchange Fund's investment performance. We expect to see some mark-to-market losses as a result of high volatilities seen in certain asset classes, including the Hong Kong equities that the Exchange Fund has committed itself to hold.
The Exchange Fund's investment objective is not geared towards short-term performance. Instead, it focuses on preserving capital, providing liquidity and backing for the Hong Kong dollar Monetary Base, and preserving the long-term purchasing power of the Fund. There could be short-term fluctuations in the performance of the Fund owing to volatile market conditions, but the emphasis has to be whether the Fund is achieving its investment objectives over the long term. We will continue to manage the Exchange Fund prudently in accordance with the investment guidelines set by the Financial Secretary on the advice of the Exchange Fund Advisory Committee.
Deputy Chief Executive
22 July 2010