When Hong Kong’s financial secretary announced plans to create a ‘Future Fund’ during his budget address in early March, everyone in the industry had the same initial reaction: finally!
It is not difficult to understand why. While state investment and pension funds across Asia have been gradually moving towards a more diversified asset policy mix and ramping up allocations to alternatives, the Hong Kong government has been far too cautious in investing its fiscal reserves.
The Hong Kong Monetary Authority (HKMA), the city’s de-facto central bank tasked with making investments, has mostly stuck to bonds and public equities, with the objective of “maintaining liquidity even if the returns are lower,” as a university professor part of the government-appointed committee responsible for drafting recommendations for the fund recently remarked in a radio interview. Whatever little private equity and real estate investments that have happened have been ad-hoc and sporadic.
That could now change with the new state investment fund, targeted to have a more aggressive investment approach to seek higher returns through long-term investments, as per the recommendations released by the five-member committee. The fund will have an initial corpus of HK$220 billion (€26.53 billion; $28.35 billion), which is the government’s land fund created from sales between 1986 and 1996. A designated portion from future budget surpluses will be added periodically. A lock-up period of at least ten years has been proposed.
But of most salience for PERE was that the committee has asked for 50 percent of the fund to be invested in alternative classes such as private equity and real estate.
HKMA manages close to HK$3 trillion in the Exchange Fund, of which almost HK$2 trillion is held in debt securities. In 2013, the fund managed an investment return rate of 2.7 percent, even lower than the 4.3 percent consumer inflation rate during the same period. In real terms, that meant the fund generated negative returns.
A small part of this fund has been set aside into something called the ‘Long Term Growth Portfolio’, which has close to HK$89 billion in assets, three quarters of which is comprised of private equity investments. Real estate investments take up the remaining one fourth.
HKMA’s overall reluctance to diversify could be because of Hong Kong’s culture. Given the island-city’s economic dependence on the real estate industry, it would be understandable if the government authority had been looking to move away from real estate, from its short and sometimes volatile cycles and focus instead on fixed-income securities.
A wide array of investments across international, private property markets would be a defense against volatility too. GIC Private, Singapore’s sovereign wealth fund, has proved that over decades. There is probably no coincidence that, when its real estate arm was launched in 1999, a decision was made not to invest in local properties.
So far, HKMA’s communications regarding the launch the Future Fund have been low on details, leaving key points to the imagination. There was no breakdown of asset classes, no guidelines for the deployment of the fund and questions still linger about how it will be managed.
The fund size, however, is similar to that of China’s sovereign wealth fund, China Investment Corporation, when it was first launched in 2007. It is worth mentioning that CIC’s initially allocation to real estate was around 1 percent to 2 percent.
The industry expects the proposed fund’s capital to be deployed first in trophy assets in established real estate markets with a long-term hold objective; investments in regional markets in the hunt for higher yields are unlikely therefore.
As far as the management of the fund goes, the committee, which consists mostly of academics and civil servants and hardly any fund managers and investment professionals, has suggested that the HKMA be placed in charge, for now at least.
Whether a new team will be set up to manage the fund’s investments or whether the management will be outsourced in the future remains unclear. Historically, sovereign wealth funds have hired external investment advisers to manage their portfolio, but in a recent trend, many have developed their own in-house management teams.
If Hong Kong were to follow this model, the HKMA would also have to decentralize the management team. It might even set up foreign offices in targeted markets, an approach that was never adopted with the Exchange Fund.
It remains to be seen whether Hong Kong, in its attempt at creating a thriving sovereign wealth fund, will draw on its own uninspiring historical performance, or emulate the successful models adopted by other funds in its new peer group.