HK Exchange Fund sticks to its guns despite fall in income

The HKEF's managers say it is unrealistic to expect the fund to engage in short-term trading, and that it needs to avoid being easily unsettled by market fluctuations.
HK Exchange Fund sticks to its guns despite fall in income

The Hong Kong Exchange Fund will not be altering its investment approach in reaction to sharp market moves, the city’s sovereign wealth fund told AsianInvestor.

Having seen its investment income drop 64% in the 12 months to June 2015, and facing questions about its ability to withstand short-term shocks, the fund’s managers have reiterated their policy for the strategic portfolio.

The Exchange fund, which was ranked No 27 in this year’s AsianInvestor 300 survey, has assets under management of approximately $350 billion.  Its investment return in the 12 months to June was hit by a combination of stock market volatility, falling bond prices and US dollar strength.

Norman Chan, chief executive of the Hong Kong Monetary Authority, explained: “The equity portfolio recorded gains of HK$27.6 billion [$3.5 billion] in the first quarter [of 2015]. However investment sentiment turned negative amid the heightened Greek default risk, triggering a fall in European and US equity markets. This, coupled with the corrections in mainland stock markets in the latter part of June, reduced the gains on equity investments.”

Gains on bond investments were also hit by a spike in sovereign bond yields, with a resultant drop in prices in the first half of the year. And as in previous years, US dollar strength resulted in foreign exchange losses of HK$25 billion on non-dollar assets (mainly bonds and equities).

The resultant drop in net income from HK$53.7 billion to $17.8 billion looks bad but a spokesperson for the HKMA told AsianInvestor that the fund would not be altering its approach: “It is more appropriate to assess the performance of the fund as a whole and over a long-term horizon rather than focusing on a short period.”

But the fund’s investment heads acknowledge there is an issue to be addressed, as to whether the fund should be making more tactical switches. Earlier this year, Eddie Yue, HKMA deputy chief executive, said: “Some may wonder, given the vicissitude of the investment world, why can’t we swerve our investment directions in response to market movements so as to maximise gains?”

“The Exchange Fund’s statutory purposes dictate that it is not a sovereign wealth fund or an ordinary investment fund.  Nor is it a hedge fund.  We do not engage in short-term speculation, short-selling or market-chasing.  Reading too much into short-term fluctuations and redirecting investments hastily can be counter-productive, and may even inflict huge losses.”

Nevertheless, Yue added: “there is a certain degree of flexibility under this framework that allows appropriate fine-tuning in response to market changes.  But this does not mean we could engage in short-term trading or high-risk investment activities.”

Of the fund’s liabilities, over HK$1.3 trillion constitutes the monetary base and about HK$1 trillion belongs to fiscal reserves of the HK government.  The need for the Exchange Fund to maintain sufficient liquidity to support the exchange value of the Hong Kong dollar, and to meet the cash needs of the government for public expenditure, explains why bonds and cash account for about 80% of the fund’s assets.  The remaining 20% mainly consists of equities and, since 2008, a small portfolio invested in private equity and real estate investments.

Defending the fund’s position, Yue said: “It is unrealistic to hope the hindsight from previous episodes could serve as a crystal ball in guiding our investment decisions.  However, a guiding post for us in the real investment world could be to aim at healthy returns in the medium and long-term and avoid being easily unsettled by short-term fluctuations.  Investment markets, foreign exchange in particular, tend to be highly volatile in the short-term and highly unpredictable.

“Investment diversification can help reduce overall portfolio return volatility but is not immune to short-term losses in individual asset classes.  It is ill-advised to overhaul the asset allocation rashly and frequently, particularly in the face of extraordinary market conditions.”

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