The exchange fund half-year results

inSight

24 Jul 2003

The exchange fund half-year results

The investment return on the Exchange Fund in the first half of 2003 has beaten the investment benchmark. The challenge for the rest of the year will be to hold on to the gains made so far.

On the basis of preliminary figures for the first half of 2003, the Exchange Fund, under the management of the HKMA, once again achieved a rate of return that is higher than that for the benchmark portfolio determined by the Financial Secretary on the advice of the Exchange Fund Advisory Committee for measuring its investment performance. As usual, this was achieved through prudent deviations in our asset allocation against the benchmark, involving the maintenance of an overweight position in certain asset classes and underweight in others.

It is probably the very significant investment income of HK$47.8 billion earned by the Exchange Fund in the first half of the year that will be of most interest to readers (a total return of 5.1% for half a year on average total assets). This already exceeds the investment income earned in the whole of last year of HK$47 billion. But I must emphasise again, as I do every time I talk about the mid-year investment results: do not multiply the number by two and expect the full year investment income to be at that level. You are sure to be wrong. And, in fact, to be quite honest, I shall be relieved if we manage to hold on to the HK$47.8 billion investment income through to the end of the year. A rough breakdown in terms of the sources making up the investment income of HK$47.8 billion for the first half is as follows:

Profits from bonds and other investments of HK$19.2 billion

Profits from exchange gains of HK$14.9 billion

Profits from appreciation of Hong Kong equities of HK$2.9 billion

Profits from appreciation of non-Hong Kong equities of HK$10.8 billion.

This year, the "easy money" has already been earned in the first half. The long-expected rally of the euro came, benefiting diversified multiple-currency portfolios using the US dollar or currencies fixed to the US dollar as the accounting unit. Concerns over deflation intensified and therefore the general policy bias towards lower interest rates provided much support to bond prices. Equity markets across the world were poised for some recovery, particularly the US equity market, after the historically rare fall for three consecutive years.

But what is to come next? This is the question that must be occupying the minds of all investment managers, particularly those having an international mandate. Continued, genuine concern about the very large balance of payments deficit of the US has, more recently, been shadowed by the generally pessimistic outlook for the economy of major countries in euroland, to the extent that a fairly significant correction has been seen in the exchange rate of the euro. Meanwhile, favourable domestic financial developments in the US, plus the heavy dose of fiscal stimulus, point to the possibility of renewed vigour in the US economy, which would undermine the chances of continued gains in the bond market. After all, US interest rates are already at their lowest levels in 45 years and the room for further downward adjustments must be limited.

So the challenge is, as I said, to hold on to it. But, because of the market sensitivity of the information, I am sorry that I cannot be more transparent or specific on our investment strategy for the second half of the year. I can assure readers that we shall continue to do our best in the investment management of the money that belongs to the people of Hong Kong.

The investment return accruing to the fiscal reserves placed with the Exchange Fund, under the profit-sharing arrangement, amounts to HK$15.1 billion in the first half of the calendar year. This already exceeds the budget figure of HK$12.1 billion by HK$3 billion. If we can hold on and possibly add to it in the second half of the year, we will have done more than expected in contributing to alleviating the budget deficit. My earlier comment about the Government's assumption on the investment return on the fiscal reserves being overly optimistic, notwithstanding the fact that I was thinking of the trend rate of return of 4.5% per annum, now appears to have been too cautious, at least for this year.

 

Joseph Yam

24 July 2003

 

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