Hong Kong’s new sovereign institution, the Future Fund, may receive up to one-third of the government's annual budget surplus every year to add to the HK$220 billion ($28.4 billion) it started with when it launched on January 1. The surplus is forecast to be HK$37 billion for 2016.
The fund’s assets are being invested by the Hong Kong Monetary Authority’s (HKMA) existing HK$3 trillion Exchange Fund. Since the new institution will put at least half of its allocation in alternative assets, returns are expected to be in line with the Exchange Fund’s long-term growth portfolio (LTGP), which includes private equity and property investments outside Hong Kong.
The Future Fund was first proposed in March 2014 as a way to alleviate potential structural deficits in the coming decade. Its initial HK$220 billion endowment has come from the Land Fund, which was created from government land sales. Thereafter, the government may provide periodic top-ups.
A working group set up last year recommended that half of the Future Fund's allocation should be to alternatives and the rest to bonds, equities or other long-term investment products, as reported.
The group also suggested that between one-quarter and one-third of the government’s annual budget surplus be transferred to the fund as a regular top-up, with the flexibility to adjust the amount depending on community needs and the fiscal situation. For 2016, the government budget surplus is forecast to be HK$37 billion, which means that HK$9 billion to HK$12 billion would be transferred.
The placement under the supervision of the Exchange Fund is for an initial 10 years. As a long-term savings scheme, withdrawal of the Future Fund before December 31, 2025 is not allowed, except in emergencies.
The government’s confidence in the Future Fund concept has been bolstered by the performance of the LTGP’s alternatives portfolio, which returned an annualised 13.5% from its inception in 2008 to the end of 2014. More recent performance figures have not been made available.
The alternative investment portion of the portfolio will be built up over a period of around three years, said Exchange Fund deputy chief executive Eddie Yue.
The LTGP made its first alternative investment in early 2009, which Yue said was good timing. “After the global financial crisis, many quality assets were sold at a discount while there was limited ‘dry powder’ from other investors,” he noted. “The assets we snatched up in 2009 turned out to be the best performing ones till now.”
Investing in alternative assets is challenging, added Yue. “Therefore, our strategy is to have a nimble and capable in-house investment team underpinned by the support of external investment managers.”
Elisabeth Tse, chair of the working group on long-term fiscal planning, acknowledged that the investment style was “aggressive”. However, she said the fund would be able to adopt a long-term investment horizon (between five and 10 years) because the city had a current account surplus of HK$760 billion, which would be growing for at least the next few years.
Given these healthy reserves, there should be little need for the government to draw on the Future Fund, noted Tse. Hence it can theoretically be more aggressive and invest substantially in illiquid assets.
Other sovereign wealth funds around the world typically set up a separate investing institution, as with Singapore’s Temasek and GIC, and Korea Investment Corporation. However, that course of action requires legislative backing and would take more than a year of government and legislative processing, as well as requiring extra time and cost for the appointment of governing boards and asset managers.
Instead, the working group recommended using the HKMA and its existing infrastructure and expertise to provide economies of scale while keeping costs to a minimum. “It is not a total solution but would help alleviate the pressure of our future generations," the government spokesman added.
The HKMA’s reserves management department focuses on due diligence work and supervises the overall strategic asset allocation and risk control of the Future Fund portfolio. Under the new arrangements, the HKMA must consult the financial secretary and the secretary for financial services and the treasury once a year on asset allocation for the portfolio.