Hong Kong's wealth fund is doing a lousy job investing our money

Last year's negative real return for the Exchange Fund follows a pattern, so perhaps it’s time to call on outsiders to manage a portion of the assets

PUBLISHED : Friday, 24 January, 2014, 2:13am
UPDATED : Friday, 24 January, 2014, 10:11am

You may not know about it, but Hong Kong has a sovereign wealth fund.

It's called the Exchange Fund. It manages assets of HK$3 trillion, and its investment performance is abysmal.

Yesterday the Hong Kong Monetary Authority announced the Exchange Fund's results for 2013. It managed a return of just 2.7 per cent.

When you consider that consumer inflation in Hong Kong last year was 4.3 per cent, that's really not very impressive. In real terms the Exchange Fund's return was negative.

This money could, and should, be invested with a little more imagination

Then, when you go on to consider that the benchmark S&P 500 Index of US stocks rose a handsome 32 per cent in 2013, the Exchange Fund's performance looks even worse.

If this dismal return was a one-off, you could forgive the fund's managers. After all, the bond market, where they keep most of their assets, took a nasty beating last year as expectations grew that the US Federal Reserve would scale back its "quantitative easing" programme of asset purchases.

But there was nothing unusual about the Exchange Fund's poor performance in 2013.

Since it was set up in 1994, the fund has generated an average annual return of 5.4 per cent.

That might not sound too bad at first. It means that HK$100 invested in the Exchange Fund in 1994 would have been worth HK$287.69 at the end of last year.

However, if the same HK$100 had been invested in the US stock market, it would have ended last year worth a thumping HK$583.53. That's despite two crashes in the US stock market in the intervening years.

And if our HK$100 had been used to buy 10-year US Treasury bonds, today it would be worth a respectable HK$379.46.

In other words, over the last 20 years, the Exchange Fund has underperformed the US Treasury market by an astonishing 90 percentage points (see the chart).

That's a spectacularly bad track record of investment.

To be fair, some of the Exchange Fund's money has to be kept in highly liquid low-risk assets in order to back Hong Kong's monetary base and underpin our currency peg to the US dollar.

But that only requires around HK$800 billion of the fund's HK$3 trillion in assets under management.

Most of the rest - around HK$1.6 trillion - consists of the government's fiscal reserves and the Exchange Fund's own accumulated surpluses.

In effect, this is Hong Kong's own sovereign wealth fund. This money could, and should, be invested with a little more imagination in order to generate decent long-term returns.

The Exchange Fund is moving in this direction, but only at a snail's pace. In 2008 it set up something it calls the Long Term Growth Portfolio, which at the end of last year managed HK$89 billion, with roughly three-quarters of its assets in private equity and the rest in property.

According to HKMA boss Norman Chan, the annualised internal rate of return on this portfolio over the last five years has been around 16 per cent.

That's encouraging, but the Long Term Growth Portfolio remains only a small proportion of the fund's assets.

Chan says he plans to diversify the Exchange Fund's investment portfolio further.

But maybe he should be asking whether the fund should follow the example of other sovereign wealth funds including the China Investment Corp and allocate a portion of its assets to outside investment advisers.

The money in the Exchange Fund ultimately belongs to the people of Hong Kong, and so far the HKMA hasn't done a terribly good job managing it on their behalf.

Perhaps the time has come for Chan to bring in some professional help. After all, outside advisers could hardly do worse that the Exchange Fund's own money managers.