EFIL comes to LIFE

In recent days Exchange Fund Investment Limited, the HKMA's in-house investment adviser, has been asking a short-list of potential advisers what should be done with the HK$160 billion portfolio acquired in last August's intervention. In this article, we present our solution.

EFIL comes to LIFE
8th February 1999

When the government issued its "mother of all buy orders" last August, it set itself the mother of all conundrums. It became the owner of shares now worth some HK$160 billion at current market prices. That's about 15% of the free float.

Conscious of the fact that it is now the second largest shareholder in most of the largest listed companies, the Monetary Authority decided to appoint an investment adviser. First of all, it created its own, Exchange Fund Investment Limited, or EFIL, which has a board of the great and good, only one of whom, outside of the HKMA, has a fund management background

The board of EFIL quite rightly recognised that it was out of its depth, and so it has turned to the market for solutions. Hong Kong's deal-starved investment banks needed no invitation, but got one anyway, to make proposals for their advisory services. Last week they were busy pitching their glossiest presentations on how to paint your way back out of a corner.

At the same time, in what we are assured is an unrelated move, the government is reviewing whether it is prudent to have all our foreign reserves invested in safe, boring bonds. Surely Sir would like something to spice up his US$90 billion portfolio? How about, for the sake of argument, 20% in Hong Kong equities? You can see where we are heading; wouldn't it be convenient if the "optimal" weighting in equities for our reserves happened to be what we already hold?

Of course, there is only one optimal level, and that's zero. Governments exist to provide law, order and community infrastructure, not to manage our savings for us. No amount of setting up wholly-owned companies would be able to insulate the ownership of stocks from ultimate control by the government, and Alan Greenspan has said as much in opposing the suggestion by the Clinton administration that they should invest social security payments in the stock market. Maybe they hope to stop the US bubble from bursting, but that's another story.

The government portfolio contains only the 33 constituents of the Hang Seng Index, which has out-performed the Mid-Cap Index by about 40% since the intervention began. It makes for an inefficient economy when some companies have an artificially lower cost of capital than others, and we should not prolong this situation.

Assuming, perhaps optimistically, that the government decides to sell, then how should they sell? Dumping it all on the market in one go runs the risk of a crash. It would be the equivalent of the US government selling about US$1,500 billion on Wall Street. On the other hand, failure to announce an orderly sale process will create uncertainty and impede any recovery. Traders call it "overhang" - we know that the stock is out there, and could be dumped at any time.

Surely the solution is for the government to think of the stocks as pieces of land. As the biggest player in the land market, it has long adopted a policy of announcing its land sale programme a year in advance. Even when the programme is empty, they say so. That creates certainty, and other participants in the property market can plan accordingly. Doing the same thing with the stock portfolio would create the same type of certainty.

Most fund managers have concluded long ago that it is almost impossible in the long run to "time the market", buying low and then waiting for a "high" to sell. If the government attempts to do this, then along the way, they would be faced with repeated conflicts. For example, should it announce next year's land auction programme before, or after, it tries to sell a block of property developers' shares? Besides, the purpose of intervention was never to make money by cornering the market, and any gain should be an unexpected bonus.

So let's have a firm timetable for a gradual sell-down of the portfolio. Something like 5% of the portfolio per month, or around HK$8 billion, should be manageable and would take us up to the end of 2000. The monthly sale would be equivalent to about two days' normal trading volume.

Sales could be made to institutional investors by sealed tender or auction. A portion could also be set aside for sale to the public, who could be offered shares in an index-tracking fund built with stock purchased from the EFIL portfolio and administered by professional fund managers, who would tender annually for the work at minimal cost, because index funds don't need research or trading. The shares in this fund could themselves be listed on the Exchange, creating a new vehicle through which investors could buy a diversified index exposure without having to buy all 33 stocks or trade riskier index warrants.

There are no easy answers to this conundrum, but a commitment to a schedule of sales seems to be the least unattractive solution.

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EFIL comes to LIFE 8th February 1999

EFIL comes to LIFE
8th February 1999