Exchange Fund profit falls but it's not as bad as it looks

Investment returns drop 64 per cent amid a sluggish stock market but results did not reflect gains in areas such as private equity and real estate

PUBLISHED : Tuesday, 06 May, 2014, 12:42am
UPDATED : Tuesday, 06 May, 2014, 8:44am

A sluggish stock market dealt a severe blow to the Exchange Fund in the first quarter of the year, dragging down its investment returns 64 per cent from the previous quarter.

The Hong Kong Monetary Authority yesterday declared the Exchange Fund made HK$11.1 billion from its investments in the first three months, compared with HK$19.1 billion in the same period last year.

The 42 per cent year-on-year drop came on the back of a 5 per cent drop in the Hang Seng Index.

"The return for the first quarter is totally unimpressive," said lawmaker Albert Ho Chun-yan, who attended the HKMA's presentation to the Legislative Council.

"There should be an explanation why the results were much less impressive than the investment record of the past two years … They [the HKMA] pursue a very prudent investment strategy, and there should not be such big fluctuations in investment returns."

The HK$3 trillion Exchange Fund is managed by the authority as a reserve to defend the local currency. It invests the reserve in stocks, bonds, property and currencies. The government also draws down on this fund, taking a cut of its investment profits each quarter.

The fund made a profit of HK$81.2 billion in 2013 and HK$111.6 billion in 2012. The first-quarter data indicates the fund is on track to make just about half the profit it made last year.

However, a closer look offers hope. For example, the fund did not include in its results its gains from "other investments" - private equity and real estate - because the figures were not yet available.

The fund earned HK$6.4 billion from "other investments" in the last quarter of 2013.

Assuming it matches that performance in the first three months of this year, the total profit drop from the previous quarter would be 43 per cent, or down just 8 per cent from the corresponding quarter last year.

The HKMA's HK$6.8 billion loss on Hong Kong equities in the first quarter was likewise not as bad as it seemed.

The authority declared that it had HK$152.9 billion invested in Hong Kong equities as of the end of last year. The Hang Seng Index dropped 4.9 per cent in the first quarter.

Had the fund exactly tracked this index, it would have lost HK$7.5 billion in the first three months of the year. But it lost HK$6.8 billion, indicating it outperformed the wider market.

The fund also turned around its bond portfolio in the first quarter. It lost HK$19.1 billion on bonds for the full year 2013, but made HK$13.2 billion on this category in the first quarter. Given that bonds represent about two-thirds of the fund's assets, this is the key category.

The good bond returns were a result of the fund's holding of US treasuries, which rallied sharply in January.

Cold Canadian weather into the United States shut cities and single-handedly impaired the American economy.

Investors looking at the GDP data thought the US economy was going through something more serious than a weather-related slowdown and sought safety in defensive securities such as treasuries.

"A lot of people had been short in terms of their position in US treasuries. They then had to cover the short positions when prices rallied in January," said Guy Stear, head of research, Asia, at Societe Generale.

The fund also made less money on foreign equities in the first quarter. The returns from the Japanese, European and American share markets were strong in 2013 but those gains were unusual and unlikely to be repeated this year.

"The goal of the Exchange Fund is more about capital preservation," said Stear. "With that in mind, they have had a good performance."