Despite volatile global markets, especially in the second quarter, the HKMA earned for the Exchange Fund an investment return of HK$30.7 billion in the first half of 2006.
The numbers for the Exchange Fund at the end of the first half of the year are now available and it is time to report them, focusing on the investment aspects, which are always a matter of interest of the community. But I have to preface this report by reiterating a few points as a necessary foundation for an objective interpretation of the numbers. First, the Exchange Fund is not an investment fund, although it has to be invested. It is a fund established by law for specific purposes, generally referred to as the maintenance of monetary and financial stability. Secondly, the strategy for investing the Exchange Fund is, in consequence, a conservative one, with a strong emphasis on preserving capital and maintaining a high degree of liquidity: this strategy is prescribed by the Financial Secretary with the advice of the Exchange Fund Advisory Committee in the form of an investment benchmark to be observed by the HKMA as investment manager. Thirdly, all the financial assets held by the Exchange Fund are marked to market, in accordance with international accounting standards, in order to reflect their realisable value, given the contingent need for them to be liquidated in case any amount of the Exchange Fund has to be used to achieve its statutory purposes.
A further point that needs to be kept in mind in interpreting these numbers is the volatility in financial markets, which has intensified in recent months: I explored some of the factors behind this volatility in last week's viewpoint. Those active in global financial markets will realise how difficult it has been to make money in the second quarter, although those investing only in the equity market in Hong Kong should have made some gains. With the exception of Hong Kong, and despite a sharp rebound at the end of June, the major equity markets around the globe fell in the second quarter, substantially reducing the gains recorded in the first quarter. In the case of the Japanese stock market, the fall in the second quarter more than eliminated all the gain in the first quarter, resulting in a net fall of nearly 4% in the first half of the year. In the bond markets, with interest rates continuing to rise, contrary to market expectations that interest rates would peak, bond prices fell significantly across the board in all major markets, hurting funds with a predominant holding of bonds. The currency market has nevertheless been helpful to multi-currency funds with the US dollar or currencies linked to it as the accounting currency, as is the case with the Exchange Fund, which presents its accounts in Hong Kong dollars. The US dollar depreciated considerably more in the second quarter than in the first against major currencies, notably the euro and sterling but less so the yen, making possible some exchange gains.
The sharp rebound in markets at the end of June, and movements since then, underlines the importance of viewing the performance of the Exchange Fund over the longer rather than the shorter term. Had the half year ended a few days earlier (or indeed a week or so later), the investment return would have been somewhat lower. These volatilities also prompt the standard caution: do not expect the full-year results to be a figure that is double the half-year results.
With these cautions and qualifications out of the way, we can now turn to the actual numbers. The HKMA earned for the Exchange Fund an investment income of HK$30.7 billion in the first half of 2006. This is 167% more than the investment income for the first half of 2005 and equivalent to 81% of the investment income for the whole of 2005. The detailed numbers are in our press release issued today. We did particularly well on the Hong Kong equities portfolio, which contributed HK$10.7 billion to the return. Bonds and other investments accounted for HK$4.2 billion, and other equities another HK$3.5 billion. The appreciation of foreign currencies against the US dollar resulted in an exchange gain of HK$12.3 billion.
The share of this investment income for the fiscal reserves placed with the Exchange Fund is $8.7 billion. Despite the strong performance of the Fund in the first half of 2006, this is some distance away from the budget estimate of HK$18.2 billion for the investment return on the fiscal reserves for the whole of 2006. Whether or not we can meet this budgeted return will, of course, depend very much on financial market conditions for the remainder of the year. Given the growing volatility in markets, how exactly these conditions will develop is a matter of great uncertainty. Needless to say, we shall continue to do our best to achieve as good a return as possible, within the necessary constraints imposed by the Fund's investment objectives.
Joseph Yam
27 July 2006
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