Howard Lee: Here comes the Black Swan


27 Apr 2020

Howard Lee: Here comes the Black Swan

When we announced the investment performance of the Exchange Fund in 2019 before this year’s Lunar New Year, market sentiment was favourable with the signing of the first phase of the US-China trade deal and initial signs of stabilisation in the global economy.   However, things turned sour shortly afterwards as the novel coronavirus spread quickly across the globe and became a pandemic in a short period of time.  In order to contain the spread of the virus, governments all over the world have put forth stringent anti-epidemic measures.  Production and consumption activities have come to a near standstill.  Despite the series of monetary and fiscal measures implemented by the various governments, it is expected that the pandemic will deal a heavy blow to the global economy.   The International Monetary Fund has just made a major downward revision to their global economic growth projection to -3%, which is the worst scenario since the Great Depression 90 years ago.  In financial markets, the term “Black Swan” is often used to describe an unpredictable or unforeseen event with extreme consequences.  In this context, the Black Swan has arrived.

The pandemic, together with the Russia–Saudi Arabia oil price war, have led to a sharp deterioration in market sentiment, resulting in significant corrections in global stock markets.  Take US stocks as an example.  The S&P 500 index fell by 30% in just around a month after reaching its record high in February this year.   The adjustment is faster than that during the Global Financial Crisis in 2008.  Even with the two surprise rate cuts by the US Federal Reserve in March by a total of 1.5%, the US stock market has not reversed its downward trend.  In mid-March, the VIX index, often referred to as the “fear gauge” of the market, also surged to an all-time closing high.

Amid the sudden outbreak of the coronavirus and the sharp volatility in financial markets, many institutional and retail investors recorded double-digit loss in terms of return in the first quarter.  Most conservative mixed asset funds under the Mandatory Provident Fund system, in spite of having a smaller share of equity holdings, also recorded a near 6% loss.  Although the Exchange Fund mainly invests in bonds, supplemented by some equities and alternative investments, the Fund will inevitably record a loss in the first quarter given the sharp correction in the global equity markets.  We will announce the actual figures in May.  This being said, as a long-term investor, the Exchange Fund’s objective is to achieve more stable returns in the medium and long term through investment diversification.  Therefore, as we have emphasised many times, the investment performance of the Exchange Fund should not be assessed by solely the figures of a single quarter.

As far as the investment management of the Exchange Fund is concerned, the future is still plagued with challenges.  There are two main reasons:-

First, the current situation is more than an economic crisis.  Monetary and financial measures have limited effect in addressing this crisis and it is still uncertain when the global economy will start to recover.   After all, governments around the world have taken tough measures because currently there is still no effective cure for the virus and vaccines are still in development.  As a matter of expedience, central banks and governments have made use of monetary and fiscal policies to avoid large scale closure of businesses.  Some places have tried to maintain economic activities as far as possible while striving to contain the virus.   However, these are just “band-aid” solutions, buying time for the research and development of effective medicine and vaccine which take time and cannot be rushed.  At least in the near future, it is expected that the global economy will remain weak and corporates will face immense difficulties which may result in shocks to the financial markets with further implications on the investment performance of the Exchange Fund.

Second, the relaunch of Quantitative Easing (QE) in the US will weaken the effectiveness of risk diversification in the Exchange Fund through bond investment.  Since the Exchange Fund must always stay highly liquid to safeguard Hong Kong’s monetary and financial stability, US bonds have been a major investment vehicle for the Exchange Fund.  In normal times when the “equities down, bonds up” pattern holds under market turbulence, bonds can help diversify risks and strengthen the entire portfolio mix's resilience against shocks.  The Fed's sharp rate cuts and relaunch of QE, coupled with safe-haven demand, have triggered yield falls and price surges in US Treasuries in the first quarter of this year.  As a result, the Exchange Fund's bond holdings have indeed recorded gains accordingly.  However, as US Treasury yields have fallen to levels nearing or even lower than those when the ultra-loose monetary policy was implemented by the US ten years ago, there is limited room for bond prices to go up further and little promise for interest returns in this low rate environment.   The conventional “equities down, bonds up” pattern will be much less pronounced, with implications for the Exchange Fund’s resilience.

In this extraordinary time, we will focus on defensiveness and liquidity when managing the Exchange Fund’s investments.  First, we have already adjusted the Fund’s asset allocation over the past few years to minimise the potential negative impact from financial market volatility.  For example, we have reduced the Fund’s non-US dollar holdings, hence mitigating the negative currency translation effect arising from a strong US dollar.  We have also expanded alternative investments (such as infrastructure investments) under the Long-Term Growth Portfolio to further reduce the correlation between the returns of different asset classes in the Fund and achieve risk diversification more effectively.  We will closely monitor market conditions and adjust our asset allocation as required in a timely manner to ensure that the Fund remains appropriately defensive.  On the other hand, we will also increase the liquidity of our portfolio to ensure the Fund can readily liquidate assets to provide funds for maintaining Hong Kong’s monetary and financial stability while meeting the Government’s needs in withdrawing fiscal reserve deposits to deal with the epidemic. 

To mitigate the negative impact of market volatility on the Exchange Fund; to ensure that the Fund can play its stabilising role in this unusual time; and to enhance value for the Fund in the long-run: these are the tasks ahead of the Exchange Fund investment team and myself, and we shall do our best to accomplish them. 


Howard Lee
Chief Executive Officer, Exchange Fund Investment Office
Hong Kong Monetary Authority

27 April 2020

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Last revision date : 27 April 2020