The Exchange Fund results for 2002

inSight

16 Jan 2003

The Exchange Fund results for 2002

The Exchange Fund showed a very healthy return in 2002, despite a difficult investment environment.

It is time again to hand in the "assignment" on the investment management of the Exchange Fund. I do this with considerable trepidation, not least because of the continuously increasing expectations surrounding our performance of this task. Many expect the Fund, at least, not to mirror the performance of the private sector investment funds, the majority of which have lost money in 2002. Others are more demanding, perhaps unfairly so (since they ignore the need for liquidity and of marking investments to market), expecting the Fund to do better than it would have done had it all passively been placed in long-term US Treasury bonds. The Government expects the Fund to perform well enough to meet the budgeted return for the fiscal reserves, and hope for the better, so that the budget deficit can be smaller than it would otherwise be. The Financial Secretary, as controller of the Exchange Fund, expects the Fund at least to match the return of the benchmark asset allocation (the benchmark return) approved with the advice of the Exchange Fund Advisory Committee.

Whatever the expectations, I think the HKMA investment team managed in 2002 to meet them all. We did not lose money. We made, before expenses (principally interest on the money borrowed) HK$47.0 billion. The rate of investment return was 5.1%. This, obviously, beats the (currently negative) inflation rate of Hong Kong, thus preserving and significantly enhancing the purchasing power of Hong Kong's reserves. It also compares favourably with the interest return on long-term US Treasury bonds - not that this is an objective or fair comparison. The Government budgeted for investment income of HK$12.6 billion for the operating account and HK$1.1 billion for the capital account, or a total of HK$13.8 billion, as return for the fiscal reserves. Notwithstanding the fact that the fiscal reserves have, during the year, been depleted a lot faster than expected, so that there was in fact a smaller principal to invest, the actual amount of return for the fiscal reserves in 2002 was significantly higher, at around HK$15.7 billion. Fiscal reserves placed with the Exchange Fund have already fallen to HK$301.7 billion by the end of 2002 and look likely to be depleted further. Last but most important, at least to the HKMA as investment manager, we were able once again to beat the benchmark return set for us by the Financial Secretary with the advice of the Exchange Fund Advisory Committee, this time by a margin of 120 basis points.

As in 2001, we did well in the bond portfolio in 2002. Interest income from and investment gains (when marked to market) in bonds amounted to HK$54.3 billion in 2002. We also did well in currency allocation, and exchange gains, benefiting from the appreciation of the euro and the yen of 18% and 10% respectively, amounted to HK$27.3 billion. But there were continuing losses in equities (net of dividends), in Hong Kong and overseas, in line with the disappointing performance of the equity markets, amounting to HK$34.6 billion. The sum of these three numbers, the HK$47.0 billion mentioned earlier, is thus the investment return for the Exchange Fund in 2002.

There were, of course, interest and other expenses incurred. For example, we have about HK$122.9 billion borrowed money in the form of Exchange Fund paper issued, on which market interest is paid. There are good monetary and market development reasons for issuing the paper and incurring the costs thereon. The paper provides the important cushion to absorb the pressure of volatile capital flows exerted from time to time on our domestic interest rates. Through providing benchmark references to longer-term interest rates (up to ten years) it is also an essential element of Hong Kong's debt market. After deducting these and other expenses, and the investment return for the fiscal reserves, we have a net "surplus" of HK$24.7 billion in 2002. This has the effect of increasing the Accumulated Surplus of the Exchange Fund from HK$302.6 billion at the end of 2001 to HK$327.3 billion at the end of 2002 - a positive outcome in rather difficult circumstances.

 

Joseph Yam

16 January 2003

 

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Last revision date : 16 January 2003