EXCHANGE FUND EXPECTED TO POST WORST QUARTERLY LOSS

‘Perfect storm’ in global markets erodes returns and puts fund on course for record annual deficit

The Exchange Fund, the war chest used by the city to defend its currency peg with the US dollar against short-seller attacks, is expected to report this week its worst quarterly loss on record amid a “perfect storm” in global markets that has eroded its investments, analysts said.

Eddie Yue Wai-man, chief executive of the Hong Kong Monetary Authority (HKMA), which manages the Exchange Fund, will present the fund’s investment returns at a meeting of the Legislative Council’s financial affairs panel tomorrow.

“Caught in this perfect storm, the Exchange Fund, as with other investors, could not stay totally unscathed,” Yue wrote in a profit warning in July a few days before the announcement of the fund’s first-half investment returns, citing volatile asset prices.

The concurrent declines in the equity, bond and currency markets were also expected to erode returns.

Louis Tse Ming-kwong, managing director at Wealthy Securities, said it was “inevitable that the Exchange Fund will report a substantial loss during the third quarter” because rising interest rates and high market volatility had hurt the performance of the global stock, bond and currency markets.

The loss for the JulySeptember period might widen from the second quarter, which was already the second-worst quarterly loss on record, at HK$95.4 billion, Tse said.

It might even challenge the worst quarterly deficit of HK$112 billion recorded in the first three months of 2020 when the coronavirus pandemic first hit.

Established in 1935, the Exchange Fund had HK$4.57 trillion of assets as of the end of last year.

The fund has suffered two annual losses in the recent past, in 2008 and 2015. Each of these has been characterised by a major financial market crisis – the Lehman Brothers collapse in the first instance and a crash in mainland equities in the second.

Tse said that even if it were to rebound in the fourth quarter on the back of a better performance of global stock markets, it was still on course to exceed its 2008 loss and report its worst yearly performance ever.

The HKMA has been reporting the Exchange Fund’s quarterly performance since 2003. If the fund reports another quarterly loss, it will be the second time in its history – after the 2008 global financial crisis – it has recorded three consecutive quarters of deficits.

The fund reported a record HK$144.2 billion loss for the six months to June 30. This includes a deficit of HK$48.8 billion in the first quarter. The loss for the first half is already double the fund’s worst annual loss of HK$75 billion for 2008.

The HKMA told lawmakers in a paper circulated on November 23 the third quarter would be a challenging one.

“Heightened market volatility continued as surging inflation, hawkish central bank monetary policy tightening, geopolitical conflicts, energy crisis and worries about economic recession have dominated global financial markets in the third quarter of 2022,” it said.

Global bond and equity markets each fell by 7 per cent in the third quarter, marking the continuation of the rare occurrence of an “equities down, bonds down” situation, according to the paper, which is based on the Bloomberg Global Aggregate Total Return Index and the MSCI All Country World Index.

In the United States, the S&P 500 fell by 5.3 per cent during the third quarter to its lowest level in nearly two years, while the Hang Seng Index tumbled by 21.2 per cent to its lowest level in 11 years. In the first nine months of 2022, global bond markets lost 20 per cent and global stock markets plummeted by 27 per cent, the HKMA paper said.

“The Exchange Fund has failed to report good results as this year is abnormal,” said Kenny Wen, head of investment strategy at KGI Asia. “A balanced portfolio will find that it has dropped by more than 20 per cent this year, the worst since 1930.”

Rising interest rates in the US have resulted in a strong US dollar, while the pound has plummeted to a record low and the euro has hit a 20-year low.

“After several rounds of interest rate increases this year, the dollar has become stronger against other currencies,” said Tom Chan Pak-lam, chairman of the Hong Kong Institute of Securities Dealers.

“The Exchange Fund’s investments in assets denominated in euro, yen and other currencies are set to suffer valuation losses [as a result]. The stock market in Hong Kong has also performed badly in the third quarter.”

The fund was likely to report a record loss for the whole year “because it is hard to catch up in the fourth quarter”, he added.

Moreover, Hong Kong must follow the US Federal Reserve and raise interest rates in lockstep despite being in an economic recession this year.

At the end of last year, the fund had invested 72 per cent of its assets in bonds, 12.3 per cent in overseas stocks, 6.6 per cent in deposits, 5.1 per cent in other assets such as overseas property or other private equity investment, and 4 per cent in local stocks, based on HKMA data.

Hong Kong famously relied on the fund to defend its currency and financial markets against an attack by short-sellers led by George Soros in late 1997 and 1998. This year, the HKMA has used the fund to buy HK$241.2 billion in 40 interventions to safeguard the currency peg, in its most aggressive stance during a rate increase cycle yet.