Hong Kong's Government Weighs How to Cash Out Stock Windfall
August 13, 1999
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Hong Kong's Government Weighs
How to Cash Out Stock Windfall
By ERIK GUYOT
Staff Reporter of THE WALL STREET JOURNAL
HONG KONG -- Last August, this city's government made a risky investment: It took $15 billion of taxpayers' money and plowed it into the local stock market. The aim was to boost stock prices and prevent financial turmoil.
A year later, the results look impressive. Currency speculators who attacked the Hong Kong dollar at the time have all but vanished. Local confidence in the economy has risen. Most spectacularly, the government has netted an $11.3 billion windfall profit, or an annual return of 73% on its investment.
At least on paper -- and there's the rub. As soon as the government, now the Hong Kong market's largest investor, begins to sell its shares, it risks sending the whole market into a slump. That means current or would-be investors in Hong Kong would do well to keep a close eye on how the government executes its exit strategy.
"They've got to be very, very careful," says Julian Mayo, managing director of fund-management concern Regent Financial Services. He predicts that no matter how Hong Kong plays its cards, "there will be downward pressure on the market."
Sale of 75% in the Works
Eventually, the government plans to sell off three-quarters of its $26.23 billion portfolio, beginning the disposal process as soon as October. The remaining quarter will be retained as part of Hong Kong's government reserves.
To dispose of the bulk of the shares, the government set up a corporation, Exchange Fund Investment Ltd., which in turn has hired investment bankers -- Goldman Sachs Group Inc., ING Groep NV's ING Barings and Jardine Fleming Holdings Ltd. -- as advisers.
Hong Kong's government made money through a combination of luck and good timing. A year ago, after many Asian currencies had crumbled, hedge funds simultaneously attacked the Hong Kong dollar, which is pegged to the U.S. dollar, and sold short Hong Kong stocks. The attacks on the Hong Kong dollar helped push up interest rates, which depressed share prices amid fears high rates would hurt earnings. In a short sale, an investor hopes to profit from a stock-price drop.
Complications From Russia
To curtail such market activity and prevent interest rates from rising to a painfully high level, the government began buying shares. But what began as, in its words, a "surgical operation" soon ballooned as the unforeseen collapse of the Russian ruble caused many emerging-market fund managers to sell Hong Kong shares to raise cash. The result: The government bought far more shares than it intended. The government's massive share purchases pushed the Hang Seng Index up about 18%, to 7829 points, from its low of 6660 before the intervention.
Russia's financial woes eventually proved to be Hong Kong's boon. In late September, the U.S. government began to cut interest rates to help out U.S. banks with large exposure to emerging markets. Those lower U.S. interest rates soon translated into lower Hong Kong dollar interest rates, thanks to the link between the two currencies. Stock markets in Hong Kong, and elsewhere in Asia, began to rally. In fact, the Singapore stock market -- without a boost from government buying -- has slightly outpaced Hong Kong, more than doubling since Aug. 14, 1998, compared with the Hang Seng Index's 92% rise.
Today, as the government prepares to sell its shares, fresh concerns loom. U.S. interest rates are rising. Tensions between Taiwan and Beijing are high. The possibility that Beijing may devalue the yuan has resurfaced. So capturing a profit without rocking the market won't be easy.
Mutual-Fund Option
The government's preferred method for disposing of its shares is to sell off a large portion of its shares as a mutual fund. The government aims to begin selling it in October or November. However, if marketing the fund isn't yet completed, or markets aren't looking good, the government is likely to postpone a sale until early next year to avoid year-end computer problems, says Stuart Leckie, an Exchange Fund Investment director.
The mutual fund will track the Hang Seng Index and probably be offered at a discount to entice investors. However, other similar tracking funds have been on the market for years, making it unlikely the fund will attract first-time investors. If those who buy the fund are already in the market, then they are likely to spend less on other Hong Kong stocks -- in other words, there is no net gain of investment for the market.
The government, however, is apparently looking at a few other tactics to sell the majority of its shares.
One possibility is for Hong Kong companies to buy back their own shares. However, Robin Fox, a director at fund-management outfit Long Investment Ltd., notes that corporate balance sheets are still weak; he reckons companies can buy back at most about 3% of their shares.
Another approach would be for the government to sell exchangeable bonds that allow the bondholder to convert the bonds into shares at some point in the future, perhaps a year or two from now. This approach would delay the impact of share sales on the market. Of course, the government can simply sell its shares directly into the open market.
The government faces a fundamental problem in trying to avoid a market decline: its status as the ultimate insider.
Sensitive economic, trade and monetary data -- the government knows it all weeks ahead of regular investors. It has a better idea than others of what economic news is likely to move the market. When the government begins selling large amounts of shares, "there's a risk people in the investment community would assume it's because [the government] has seen some figures that are going to be bad," a fund manager says. If that perception spreads, the result could be a self-fulfilling prophecy, as the market plunges, hurting the real economy.
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