HK maps out aggressive HK$200bn Future Fund

Hong Kong’s proposed Future Fund should allocate around half of its assets to alternative investments, a government-appointed committee recommended yesterday.

The investment approach would be part of the government’s attempt to generate sufficient returns to counteract what are expected to be mounting deficits in public finances in the coming years.

But rather than issue mandates to external managers, the working group committee recommended handing over the Future Fund’s assets to the Hong Kong Monetary Authority (HKMA) to invest.

The fund, first proposed last March as a way to alleviate potential structural deficits in the coming decade due to an ageing population, could be funded by the city’s HK$220 billion ($28 billion) land fund, which was created from government land sales between 1986 and 1997.

If the six-strong working group’s recommendations are accepted, about HK$100 billion could be invested in private equity and real estate over several years. The remaining asset classes would be in bonds, equities or other long-term investment products.

Elisabeth Tse, chairwoman of the working group on long-term fiscal planning, acknowledged that the investment style was “aggressive”. However, she said that because the city had a current account surplus of HK$760 billion, which would be growing for at least the next few years, the fund would be able to adopt a longer-term investment horizon.

“Within the coming few years, [the city’s reserves] will remain healthy. The need for the government to have to draw on the Future Fund should be low. Hence the investment of the Future Fund can theoretically be more aggressive,” Tse noted.

The committee recommended that the Future Fund’s investment decisions should be made by the HKMA, Hong Kong's de facto central bank.

The committee’s confidence in the proposed investment strategy has been bolstered by the performance of the HKMA’s own HK$90 billion alternative portfolio within its overall exchange fund. This portfolio generated annualised returns of 13.5% from inception in 2008 to the end of 2014.

Other sovereign wealth funds around the world use different management methods, such as a separate institution with Singapore’s Temasek and the Korean Investment Corporation, or the establishment of a trust fund.

Such routes would require legislative backing and more than a year for processing through government and the legislature, the committee explained, as well as the extra time and cost of appointing governing boards and investment managers.

Instead, investing the land fund endowment through the HKMA and its existing infrastructure and expertise would provide economies of scale, keeping costs down to a minimum.

Assets would be invested through HKMA’s existing HK$3.1 trillion exchange fund.

The Future Fund would be managed as part of the exchange fund and therefore would be subjected to the same investment management regime.

Explaining this approach, Liu Pak-wai, finance research professor at the Chinese University of Hong Kong and also a committee member, said that providing HKMA with assets to manage would generate the best returns possible.

“The HKMA's investment approach will not be different to the Future Fund. Whatever investment return they get, we get too,” said Liu. “There will be an incentive for them to provide returns because their stakes are in the same funds.

“If we allocate our funds to other asset managers, you don’t know if their interest is with you to look after your money. The best way is to get the money manager to put in their own money.”

Moreover, the working group suggested that about a quarter to a third of the government’s annual budget surplus be transferred to the fund as a regular top-up, with the flexibility to adjust the amount depending on community needs and the fiscal situation.

In contrast, the 10-year investment horizon would mean withdrawals from the fund could only be made in very limited circumstances.

The HKMA's exchange fund returned 1.4% last year, but this was against a consumer inflation rate of 4% in the city. Since 1994 the HKMA exchange fund has generated average annualised returns of 5.2%, against an average annualised inflation rate of 2.2%