The Hong Kong Monetary Authority last year recorded its lowest investment return on the Exchange Fund since the de facto central bank was set up in 1993. The fund returned 0.7 per cent, about HK$7 billion, down 84 per cent from the previous year, according to figures released yesterday. HKMA chief executive Joseph Yam Chi-kwong said the Exchange Fund outperformed most private-sector funds and he was satisfied with the modest growth. But it dents government hopes of using HK$12.5 billion in Exchange Fund returns to help plug the budget deficit. The HKMA manages the fund, which serves as a reserve to protect the Hong Kong dollar. Internal and external fund managers invest the Exchange Fund in bonds, stocks and foreign currencies. About 83.6 per cent of the fund is in bonds, and the rest in equities and foreign currency. The return last year was mainly due to a market slump. Equity investments worldwide did badly, with the Hang Seng Index losing 25 per cent of its value during the year. The fund's biggest losses were in equities. Hong Kong stocks owned by the fund lost HK$27.1 billion in value, while overseas equities lost HK$3.2 billion in value. The fund lost HK$13.1 billion on foreign exchange and other transactions. But the equity and foreign exchange losses were offset by a strong performance in bonds. The fund earned returns of HK$50.4 billion on its bond holdings. The modest investment performance was one reason the fund shrank HK$42.8 billion last year to end the year at HK$980.6 billion compared with HK$1.02 trillion a year earlier. Included in the fund's outflows last year was a HK$36.6 billion withdrawal by the Government to meet its public expenditure. The Exchange Fund also paid HK$9.9 billion in interest to holders of its bills and bonds. The Exchange Fund comprises the Government's accumulated fiscal surplus, accumulated investment returns on the fund, and the monetary base, which includes certificates of indebtedness and coins issued, the aggregate balance of the banking system and Exchange Fund bills and notes issued. The largest component of the fund is the Government's fiscal surplus, which fell HK$36.6 billion to HK$380.6 billion last year. The accumulative surplus fell HK$4.4 billion last year to HK$302.7 billion. This is the first time the accumulative surplus has dropped since the HKMA was set up eight years ago. Mr Yam said that last year was an exceptionally difficult year for the world's financial markets. 'Despite the volatility in the markets, the Exchange Fund produced a positive, albeit modest, investment return.' He said the Exchange Fund had achieved a better result than other similar private funds, which had posted returns ranging from minus 0.1 per cent to minus 0.6 per cent. The Exchange Fund had recorded a compounded 6.5 per cent annual return for the past eight years, he said. However, he said the Government might not reach its goal of achieving investment returns of HK$12.5 billion from the Exchange Fund for the year to the end of March. In the past nine months, it had received investment returns of HK$7.8 billion. To meet its target, the Exchange Fund would need to improve earnings dramatically in the first three months of this year. 'I must admit I am not confident we could meet the HK$12.5 billion target,' Mr Yam said. If this happens, the Government may record a budget deficit higher than its original forecast of HK$60 billion. Looking ahead, Mr Yam said the investment outlook remained uncertain: 'The US economy may have a recovery but that may not be a substantial growth. The financial markets are very nervous and we expect volatile conditions to continue.' He said the Government would continue to dispose of the shares it acquired in the 1998 market intervention.