Volatility in the world's bond markets and the strength of the US dollar have dragged down the performance of the Hong Kong government Exchange Fund, with accumulated earnings growing by 7.9 per cent in 1996 compared to 27.3 per cent a year earlier. The Hong Kong Monetary Authority (HKMA) yesterday announced that the fund's total assets rose by 16 per cent to $534.5 billion, compared with $460.7 billion at the end of 1995. The fund, created to defend the Hong Kong dollar against speculators, recorded a net surplus for the year of $12.7 billion, a fall of 62 per cent compared to 1995's $34.3 billion. Accumulated earnings in the Exchange Fund increased to $172.8 billion. Andrew Sheng Len-tao, deputy chief executive of the authority, said the fall was due to the disappointing performance of various bond markets and the strength of the US dollar. 'The bond market was exceptionally good in 1995, while US interest rates dropped 200 basis points, which boosted the price of US dollar bonds. 'The US dollar was also weak that year, which enhanced the performance of the fund. 'These two factors contributed to the rise in the net surplus in 1995, but they were not repeated last year,' he said. The investment income of the fund was $25.3 billion last year, a 46 per cent fall from the $46.7 billion generated in 1995. Mr Sheng said that although investment income last year was lower than 1996 the fund had outperformed other bond funds. According to a report by Merrill Lynch, the world bond market recorded growth of 2.15 per cent last year, with US bonds rising 4.47 per cent, British bonds increasing 16.95 per cent, German bonds down 1.42 per cent and Japanese bonds down 8.44 per cent. The strengthening of the US currency during 1996 led the authority to increase the fund's US-dollar assets to 88 per cent, Mr Sheng said. 'The US dollar strengthened 7 per cent and 12 per cent against the deutschemark and yen respectively in 1996,' he said. 'In anticipation of the continued strength of the US dollar, we increased our US dollar holdings from 84 per cent in 1995 to 88 per cent of the total assets of the fund in 1996.' Amy Yip Yok-tak, executive director (reserves management) of the authority, said 5 per cent of the fund's total assets were invested in equities, mainly in the US and Japanese markets. A bull run on the US stock market last year had contributed to the surplus, but the authority had no plan to increase its holding in the US equity markets, she said. Mr Sheng expected 1997 to be more difficult than last year. 'The outlook for 1997 remains uncertain. 'The market consensus that US interest rates may increase in 1997, coupled with the strength in the US dollar, will impact on the fund's performance in 1997,' he said. 'The unification of European currencies may also increase their volatility.' The authority is expected to hold more short-term bonds to avoid the effects of the US interest rate rise. Ms Yip said: 'As the market predicts interest rates will be up this year, the fund will hold more short-term bonds, to avoid the negative effect of long-term bond price volatility.' The HKMA also announced yesterday that the foreign currency assets (foreign reserves) within the Exchange Fund totalled US$63.8 billion as at end of February. This represented a drop from US$65.9 billion at the end of January, due to seasonal factors associated with Chinese New Year.