2008 is set to become the worst year for Hong Kong's Mandatory Provident Fund (MPF) portfolios since the programme was launched eight years ago.

MPF assets have declined by 10%, in line with global sell-downs in the first half of this year, according to the latest data published by RCM. During the six month period: the MSCI World index fell 11.8%; Wall Street fell 14.4%; the MSCI Europe index fell 14.1%; and the MSCI Asia-Pacific index fell 13.3%.

Within Asian stock markets, where membersÆ allocations have been most concentrated, Hong KongÆs market was down by 20.5% over the period, Singapore was down 9.9%, and Malaysia was down 6.9%. ShanghaiÆs A-share market was the worst performing with a loss of 44.6%. In Europe, FranceÆs CAC 40 shed 14.9%, Germany shed 14.3% and the UK shed 12.9%. Only global bonds and US government bonds reported positive returns of 5% and 2.2%, respectively, during the period.

ôWe are not out of the woods by any means. The banking system is still extremely frail in the United States and, potentially, globally. Therefore we donÆt hold out great hope for a significant recovery in equity prices,ö says Mark Konyn, CEO at RCM Asia-Pacific in Hong Kong. ôThe markets are going to continue to test the downside level in the short term. There is no remedy.ö

Konyn warns bargain hunters looking to pick up cheap financial stocks to think twice before they act. Although the sector is now trading at a 50% discount compared to valuations 12 months ago, the nature of these business profiles have radically changed. Given the high degree of equity dilutions, it will be difficult for shareholders to regain previous price levels.

Recent news on the pain being suffered by US mortgage agencies is probably going to add to the already negative economic woes. ôAs the US government takes on more costs to fund these bail-outs, it could put pressure on the US dollar. And that in itself could lead to higher oil prices,ö Konyn says.

Konyn believes markets will remain extremely volatile over the coming months.

ôThere is still a lot of uncertainty,ö he says. ôIt appears that in the last couple of days the US is already in recession û and we would maintain that view.ö

In Europe, he sees competition between Germany and peripheral countries such as Portugal, Ireland and Spain hurting the EurozoneÆs growth prospects.

ôThese economies will need to deflate, which means there is going to be some pain in these economies. And that is something that we have taken into account very carefully when contemplating a portfolio in the Eurozone,ö he says.

Konyn says the UK is already in hard-landing territory, while JapanÆs central bank might be on the wrong track for focusing on remedying risks of inflation instead of the possibly greater danger posed by a comeback of deflation. Overall, previous prospects of a decoupling between the developed world and emerging economies have not lived up to its promise, he says.

In China, as hot money flows have slowed down since the first quarter of this year, the Chinese central bank is more likely to raise interest rates to combat domestic inflationary pressure, Konyn says. While he sees ChinaÆs inflation already peaking, he believes it is unlikely that it will return to the previous level of 2% to 2.5% because inflationary pressures remain structural.

Konyn says, however, that expectations of a global inflation spiral among investors might have been over-exaggerated. The current pace of inflation is unlike that of the era of the 1970s, when price increases and wage expectations reinforced inflationary trends, he says. Retrenchment in labour markets in the US and other developed economies will likely serve to correct the current pressure in developed markets, he says.

RCM is upholding defensive plays within the region, where it is focused on companies with high-earnings visibility. It is overweight in basic materials, industrial, non-cyclical consumers, technology and telecoms. It is allocating more of its portfolio to Hong Kong, where it is focused on energy, industrials, healthcare, utilities, telecommunications and consumer plays.

Konyn cautions MPF investors in Hong Kong not to expect the same extraordinary returns from their portfolios that they have enjoyed in previous years. Market conditions have changed from the high growth and deflationary environment of the past six years.

ôAs we move forward, the chance for us to get those high returns again is more distant. A lower level of expected return plus a higher level of inflation means it is going to be a more difficult time for asset accumulation for retirement funds,ö he says.

ôWe are looking at low single digit returns. Now, given the concerns of the first half of the year, there is no immediate prospect of global equity markets staging an immediate recovery, although we expect recovery to come towards the year-end,ö he adds.

Konyn expects it could take another two to three years before employees are freely allowed to choose their MPF providers û a focus of debate among the cityÆs legislators since last year. At present, employees choose from providers already pre-selected by their employers.

Until employees can freely choose, Konyn believes there will be little legroom to roll out new products, such as lifecycle and target-date funds û two products that have proven to be popular in the USÆs 401K market and which are gradually catching on in Hong Kong, where investors prefer making active investment choices.