Joseph Yam's investment policy still failing to add up

PUBLISHED : Wednesday, 23 January, 2008, 12:00am
UPDATED : Wednesday, 23 January, 2008, 12:00am

Commenting on the outlook for the year ahead, Mr Yam said that the investment environment would continue to be challenging in 2008.

Government news release, January 21

It is always challenging. That's the way markets work. Prices move to create a constant 50/50 balance of greed and fear. If the news is good, then prices are steep and if the news is bad, then prices fall, as they are now doing. Throughout it the investment environment continues to be challenging.

But it is another facet of the investment conundrum which interests me today. Our monetary chief, Joseph Yam Chi-kwong, has just announced a total returns gain of HK$146.9 billion for the Exchange Fund last year and he wants to warn people that there may not (will not, actually) be a repeat this year.

Think about it in your own personal circumstances. Let's say that you have a goodish sum in savings outside of the equity in your home. Okay, perhaps you don't, not since yesterday but put yourself in the position of what-if.

The money doesn't do you any good if you just leave it and let the investment gains accumulate until your heirs get it all. You want to preserve the capital but you want to enjoy some of the fruits of it too. How much of it can you give yourself every year to spend while still keeping the basic nest egg intact?

Let's say that you decide to spend 3 per cent of the value of it every year and you have settled to your satisfaction whether you mean 3 per cent of what you put in or 3 per cent of what the investment is now worth on the market.

You then remember that inflation is running at 6 per cent and you kick yourself. What is the point of taking a lower return than the rate of inflation?

So you decide that you will take out in cash all the profits that you have made over the last year. This first of all leaves you with the question of whether you should make an adjustment for inflation.

If your profit for the year was 9 per cent of the starting value of your portfolio and inflation was 6 per cent over the year, shouldn't you really take out only 3 per cent? That extra 6 per cent just goes to making up for what inflation has taken away from you in the value of your portfolio.

And, having settled this to your satisfaction, you then have to ask yourself whether you should actually cash in the investments on which you made your profit or just calculate a paper profit from their change in market value and take the risk that the market value won't go down next year.

I could keep these questions going because there are many more of them to ask. The point I want to make, however, is that they are exactly the questions our government asked itself about taking cash profits out of its holdings in the Exchange Fund and I have my doubts about the wisdom of the answers to which it came.

In his 1998 budget speech, the then financial secretary, Donald Tsang Yam-kuen, said he was no longer satisfied with transferring a fixed percentage every year from the government's savings to its revenues because this return 'has not kept pace with inflation'.

If you think about it, you will realise that he had his thinking cap on the wrong way. What matters is whether the value of the exchange fund had kept pace with inflation. How much he allowed himself to take out of it was another matter having less to do with inflation.

Donald wanted more, however, and so he ruled that in the future the amount taken out would be the investment profits for the year, unrealised paper profits included. Hey presto, the returns went up.

But, of course this also made these returns more volatile and unreliable. What goes up can come down. What you booked as a profit one year you may have to book as a loss the next if the price comes down and you never actually sold the investment.

This came to the attention of the International Monetary Fund, which frowned on the practice in an official paper and said these returns should be smoothed out.

It doesn't do for Hong Kong bureaucrats to say 'Boo!' to the IMF and their acquiescence came in the last budget speech - the return on the fiscal reserves will now be calculated on the basis of the average rate of return of the Exchange Fund's investment portfolio over the past six years.

How convenient. Just when investment markets are tanking we are to take a multi-year period in which they did well as the benchmark for how well they will do in the future, thus double counting some of the profits that the Exchange Fund has already booked and entirely ignoring that inflation is rising.

I can well understand why Joseph should be a little anxious about future returns. Not only have we spent money from profits that we never actually made and not only are these paper profits set to turn into losses soon but we are to continue pretending for years to come that they are still profits and that we can spend them a second time.

You'd be bust if you ran your personal finances that way.

Joe? Oh, he'll just change his accounting policies again.