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Recovering equity markets in the first half of 2019 helped the Exchange Fund to post decent investment returns for the year. Photo: Bloomberg

Hong Kong’s Exchange Fund reports second best year ever in 2019 even as returns weaken in the latter half due to protests

  • Investment income increased to HK$247.2 billion (US$31.8 billion) for the full year, compared with HK$10.9 billion in 2018
  • Accommodative central bank monetary policies lent support to the equity and bond markets, helping the Exchange Fund achieve a decent return on its investments, said Eddie Yue Wai-man, the HKMA chief executive

Hong Kong’s Exchange Fund, the war chest used to defend the local currency from attacks by short sellers, reported its second highest investment income on record in 2019 despite weaker returns in the second half of the year as the city underwent one of its worst political crises.

Investment income increased to HK$247.2 billion (US$31.8 billion) for the full year, compared with HK$10.9 billion in 2018. The fund had investment income of HK$252 billion in 2017, its highest ever annual return.

The fund was hit hard in 2018 as worries over the US-China trade war and China’s slowing economy weighed on Asian indices, reporting an investment loss of HK$33.6 billion in the fourth quarter of 2018. Hong Kong stocks dropped by almost 14 per cent in 2018.

Equity markets recovered in the first quarter of 2019 and the fund benefited from gains on government bonds as the US Federal Reserve moved to lower interest rates.

Hong Kong-dollar deposits rise in October, Exchange Fund declines as months-long protests continue

“Global financial markets were clouded by the slowdown of global economic growth and US-China trade tensions during 2019,” Eddie Yue Wai-man, the Hong Kong Monetary Authority chief executive, said at a press conference. “However, accommodative monetary policies by major central banks lent support to the equity and bond markets. With this favourable environment, the Exchange Fund achieved a decent return on equity and bond investment.”

Yue warned the investment environment in 2020 would remain “challenging” even as markets stabilised somewhat after the United States and China agreed to a phase one trade deal this month, calling a truce in an 18-month trade war between the world’s two biggest economies.

“Potential risks remain: progress of the next phase of the US-China trade talk, implementation of Brexit and the evolving situation in the Middle East can all potentially affect market sentiment,” Yue said.

The trade war saw the US and China place hundreds of billions of dollars of tariffs on each other’s goods, weighing on business sentiment and future investment.

Another concern is global interest rates are at a low level and there is limited room for central banks to stimulate the economy via monetary policy, he said.

Later, Howard Lee, the HKMA's deputy chief executive, said the monetary authority as “closely monitoring” the Wuhan coronavirus outbreak as it could potentially affect equity markets.

The bank’s returns in the second half of the year were much weaker as the city’s economy fell into a technical recession in the third quarter following months of anti-government street protests.

The civil unrest has hit retailers, restaurants hotels, airlines and other tourist-related industries particularly hard.

Eddie Yue Wai-man, chief executive of the Hong Kong Monetary Authority, warned on Thursday that the investment environment in 2020 would remain “challenging”. Photo: Nora Tam

The uncertainty over the protests also led to a mixed performance in Hong Kong equities. The mainland-dominated Hang Seng Index finished 2019 with a full-year increase of 9.1 per cent, but experienced a much weaker recovery than the Shanghai Composite Index, which rose 22.3 per cent for the year.

The fund recorded returns of HK$1.8 billion on its bets on Hong Kong equities in the second half, in part because of HK$12.3 billion of losses in the third quarter. That compared with gains of HK$20.3 billion in the first half of 2019.

Its gains from foreign equities fell to HK$38 billion in the second half, compared with HK$76.4 billion in the first six months of the year. That was primarily due to a weaker third quarter, with the fund recording gains of HK$30.6 billion in the fourth quarter of 2019.

The MSCI World Index ended 2019 up 25.2 per cent, as optimism grew about the phase one trade deal between the US and China.

The fund recorded a wider loss on foreign exchange of HK$9.5 billion in the second half as the US dollar strengthened. That compares with HK$3.5 billion in the first half of the year. The city’s currency has been pegged to the US dollar for 36 years.

As protests intensified this summer, concerns have grown this year that the street protests could lead to a massive outflow of capital from Hong Kong to rival cities, such as Singapore, and erode the city’s position as a premier international financial centre.

Hong Kong dollar peg: could democracy act spell the end of the city’s US dollar peg?

In December, the Bank of England estimated about US$5 billion in capital had flowed out of Hong Kong since April.

John Greenwood, Invesco’s chief economist, said earlier this month that the Bank of England should apologise for its report and said there have not been significant outflows.

“There’s been some outflow of longer term capital, but counterbalanced by inflows of short term capital,” said Greenwood, who is considered an architect of the Hong Kong currency peg. “On an overall balance of payments, because the HKMA has not had to step in, there’s been no net outflow or a reduction of reserves of Hong Kong. The Bank of England report was frankly misleading. They should apologise for it.”

Kyle Bass, a short-seller and hedge fund manager who has bet the Hong Kong currency peg would break, told Bloomberg last week that Hong Kong was potentially facing a “full-fledged banking crisis” this year.
HKMA officials have disputed his forecast, with HKMA deputy chief executive Arthur Yeun saying, “Hong Kong’s banking sector is among the safest worldwide.”

For the full year, the fund reported investment income of HK$23.4 billion on its private equity and real estate investments held as part of an initiative begun in 2009 to invest in alternative assets. Its annualised internal rate of return on those alternative assets between 2009 and the end of September 2019 was 12.4 per cent.

The Exchange Fund was established in 1935 to back the issuance of banknotes and later mandated to invest the government’s official reserves.

The Hong Kong government will receive HK$6.8 billion in the fourth quarter from the fund, bringing the total for the full year to HK$29.4 billion. The treasury places its fiscal reserve with the Exchange Fund as part of its assets, and earns a share of profit or loss from its investments.

This article appeared in the South China Morning Post print edition as: Exchange fund holds off market slowdown