Hong Kong's Future Fund: Securing the future

Hong Kong's Future fund is a large cap solution to a longstanding concern: its remit is to cover a surge in government social benefits spending over the next decade due to an aging population and slower economic growth.

The vehicle, managed by the Hong Kong Monetary Authority (HKMA), has initial capital HK$219.7 billion ($28 billion) drawn from the territory's fiscal reserves. More than half of this will be deployed in alternative assets, mainly global private equity and overseas real estate, over a three-year period. This strategy is an acknowledgement that the Future Fund is a late starter with a lot of ground to make up.

"Given that Hong Kong will likely run into big deficits in the future, but in the next 10 years or so the reserves won't have to be used, it makes sense to invest the existing reserves in assets that generate higher returns. The Future Fund serves this purpose and so its investment strategy is aggressive," says Francis Lui, a professor at Hong Kong University of Science and Technology (HKUST) who also serves on the government-backed working group that recommended the establishment of the fund.

We recommended the establishment of the Future Fund because we wanted to give a specific investment strategy to the HKMA - Marcellus Wong

As the HKMA transitions from a fixed income-heavy savings mentality to embrace alternatives more readily, the private equity industry is asking what kind of LP it will be.

Dry powder

With the government expecting the percentage of Hong Kong citizens aged over 65 to rise from 15% in 2014 to 30% by 2041 - and concerned about the pressure this would place on public services - the working group was set up to advise on bolstering the finances. It recommended last March that the HK$220 billion Land Fund should form the basis of the Future Fund, plus one quarter of annual budget surpluses as top-ops. It envisages a balance of HK$510 billion, or 14.7% of nominal GDP, by 2023-2024.

The fund came into effect on January 1 and for an initial 10-year period it has been placed with the Exchange Fund managed by the HKMA. The Exchange Fund already features a $14 billion long-term growth portfolio (LTGP) that primarily focuses on illiquid assets.

The primarily purpose of the Exchange Fund, which had a balance of HK$3.47 trillion in October 2015, is to affect the exchange value of the Hong Kong dollar in order to maintain monetary and financial system stability. It is divided into several portfolios: a backing portfolio comprising US-dollar assets; an investment portfolio targeting liquid, low-risk and short-term investments such as bonds and equities; and a strategic investment portfolio.

The LTGP was formed to invest in private equity and real estate, but it was a relatively small consideration, with the backing and investment portfolios accounting for two thirds of the fund.

"We recommended the establishment of the Future Fund because we wanted to give a specific investment strategy to the HKMA, which will earn higher investment returns on the government's fiscal reserves," says Marcellus Wong, a senior advisor at PwC and another member of the working group. "We did some research, taking account of investment risk and return. We thought that allocating half of the Future Fund to the LTGP was the right proportion. While it could optimize return, it can also lower the risk. If all or a majority of capital went into the LTGP the risk would be higher."

The Exchange Fund made its first alternative investments in early 2009 during global financial crisis. Eddie Yue, deputy chief executive of the HKMA, said this fortuitous timing resulted in the LTGP's 2009 vintage being "the best performing" of all the portfolios. Through the seven years ended 2014, the LTGP delivered an annualized IRR of 13.5%. This compares to an average return of 5% over six years for the investment portfolio.

In recent years, the HKMA scaled up its long-term investments, with new commitments of $9 billion in the first 10 months of 2015, up from $5 billion in the same period of 2014. As of year-end 2014, the LTGP's investments and undrawn commitments totaled HK$200 billion, which is still only 5.8% of the Exchange Fund.

Sitting within the HKMA, it is hoped the Future Fund can leverage the Exchange Fund's existing investment infrastructure and expertise, and also enjoy lower costs than if it operated as a stand-alone entity.

Addressing alternatives

According to industry participants, the HKMA has an alternatives team comprising about 10 investment professionals, covering private equity, infrastructures and real estate. While funds of more than $3 billion in size have been assessed directly, responsibility for investments in smaller vehicles is outsourced to advisors.

However, over the past two years, the HKMA has begun playing a more active role in due diligence on deals and GPs, including those that fall below the $3 billion threshold. As such, external advisors increasingly make investment proposals and leave it to the HKMA to review them internally.

Yue said the LTGP predominately invests in mature markets, including North America and Western Europe. However, there are plans to increase allocations to Asian markets such as China, Japan and Australia. "They have already invested in large global funds, made co-investments and also random direct investments. Like other Asian large LPs, they will continue to build their in-house team and increase their exposure to direct investments and co-investments," a fund manager observes.

Withdrawals from the Future Fund are not permitted before the end of 2025, except for in emergencies, while all returns should be re-invested in the capital pool. The idea is that a ring-fenced pool of capital ensures a more stable investment strategy.

"The program is thoughtful and in line with many institutional investors," says Joseph Chang, a principal at Mercer Investments. "They won't deploy all the capital from day one but over a three-year period, which means the HKMA can devise proper diversification of the program. If they deployed over a short period of time, people would argue that it's not the best timing to invest."

• Tweet  
• Facebook  
• LinkedIn  
• Google plus  
• Save this article  
• Send to  

• Topics
• Greater China
• LPs
• Fundraising
• Hong Kong (China)
• LPs
• Fundraising
• Sovereign wealth fund
• Hong Kong Monetary Authority (HKMA)