The prophets of doom who predicted that the Hong Kong government’s unloading of its stock market portfolio would be a disaster have been proven wrong. Its Tracker Fund of Hong Kong was massively oversubscribed at launch. But behind the offering’s success lies a tale of disputes over commissions and rebates, anxiety among some professionals that that fund would add to market volatility and concern that the government is deviating from a laissez-faire policy that has served the territory so well.
The story goes back to August 1998 when the Hong Kong government broke with tradition and spent US$15 billion (HK$117 billion) from official reserves on propping up the local share market. A year later these shares were worth $26 billion but the government faced the problem of liquidating all but 5% of this unwanted equity portfolio without creating a fresh stock market crisis. Its solution was to create a free-standing Tracker Fund of Hong Kong whose units would be sold off to investors.
At US$4.3 billion, it was Asia’s biggest public offering. Retail and institutional investors applied for at least three times the initial indicative offer size. And, on its first day of trading, it racked up profits of up to 10% for thousands of investors. Even the fund sponsors were surprised. Jardine Fleming’s director of corporate finance, George Hongchoy, said: “The response [to the fund] was more than what we had expected.”
Among the contentions created by the fund was that the stockbroking fraternity felt discriminated against because banks were not subject to the same restrictions as them on commissions and rebates. Brokers also believed that the government had not taken their views seriously. “There were no special consultations with us before the launch,” says Hong Kong Stockbrokers Association chairman Paul Fan.
There were bitter complaints over the government’s original arrangement under which only 16 designated retail brokers were to receive a 1.75% commission to be paid by the government while other brokers were only to be paid an undefined cash rebate from the 16 brokers plus a 1% commission from clients. Some brokers threatened to withdraw their support for the Tracker Fund unless they were given adequate commissions. The fund was saved from a rocky opening when a compromise plan was thrashed out after week-long negotiations. Under the new plan, the stock exchange’s 500 brokers would receive a 1.5% commission on their fund sales in addition to a 1% commission from clients for each Tracker Fund sale. The 16 designated brokers would still receive a 1.75% commission.
No sooner was this dispute resolved than the next row broke out over whether stockbrokers would be allowed to offer cash rebates to clients for the sales. This involves a long-standing source of competition between banks and stockbrokers on the right to reward clients with rebates. The stock exchange finally confirmed that brokers could do so for the Tracker Fund but that concession did not silence complaints that banks and brokers were not competing on a level playing field. One stockbroker says: “There are two tiers of justice. Banks are not governed by the Securities & Futures Commission as stock-brokers are and, as exempted dealers, they are not required to follow the SFC’s 0.25% minimum commission rule. This means banks can rebate to clients a large portion – or even all – of the commission they receive which we couldn’t do. Banks are thus able to offer better terms to clients than we are.”
The fund is designed to provide investment results that closely track the performance of the Hang Seng Index. It is an ingenious method of offloading to the public a portion of the 10% of the total stock market that the Hong Kong government bought a year ago. Given the sheer size of the portfolio requiring disposal and the need to minimise adverse market impact, the government decided to set up a company, Exchange Fund Investment Limited, and appointed a three-member advisory panel – Goldman Sachs (Asia), ING Barings Asia and Jardine Fleming Securities – to decide on a disposal strategy. It was finally decided to use the device of a unit trust product tracking the index. Financial secretary Donald Tsang said: “Compared with other disposal methods, [the fund] adopts a market neutral approach with the least impact on the prices of the underlying shares. It caters for the needs of both institutional and retail investors. It adds to the variety and depth of our stock market by introducing a new liquid product.”
The government launched a massive publicity blitz to ensure the success of the offering and added sweeteners to the deal in the form of discounts and loyalty bonuses. Stockbroker David Tsien of Jardine Fleming said: “What with 5% discount by the government, 2% brokerage rebate, implied yield of 2% on an index of 13,800 and loyalty bonuses that could add up to 14% for two years, the investor is reaping benefits of some 23% before he does anything. This is the perfect vehicle for small investors.”
The fund’s popularity with investors has not allayed the concerns of some market professionals that its drawbacks outweigh its advantages. Some are worried that the fund will add to the volatility of the market. One specialist said: “It is encouraging both the institutional and retail purchasers to buy exposure to the Hong Kong market instead of buying individual shares on the basis of their expected performance. Anything that might impact the market negatively will be a sell signal not only to those who hold the Tracker Fund but also to those holding shares directly in the expectation that the whole market will fall.”
To underpin demand for the fund, the government announced that the new Mandatory Provident Fund Schemes Authority will buy into it. The government’s effort to retreat from the stock market through the selling of the fund is thus counterbalanced by its decision to use part of MPF’s HK$5.6 billion in available funds to invest into the unit trust. If in future, the Hong Kong stock market comes under serious pressure, the government may find it almost impossible not to use the official reserves once again to prop up share prices.
Concerns about the government’s actions are widespread. Mark Mobius, president of Templeton Emerging Markets Fund, says: “The government is now a player in the market. What is the government doing getting involved in the fund management business? They will find it difficult to extricate themselves. If the market goes down, what obligation would the government think it has? There will be a dilemma. Having made the first mistake [of buying into the market in August 1998], they should now place shares in the open market and dispose of them in a transparent manner.”
Tsang’s defence is robust: “We acquired that portfolio in very exceptional circumstances when the Hong Kong financial markets were subject to merciless and sustained attacks on several fronts. Investors’ confidence was on the verge of collapse. Our action attracted a lot of criticism at the time. Some were concerned that it might signify Hongkong’s departure from free-market principles. I hope it is now clear to all that these concerns are unfounded.
“While my colleagues and I have repeatedly said that profit-making and jacking up the market were never the reasons for our incursion, profitability post-operation is powerful proof that in August 1998 the speculators had pushed down the market to an artificially low level that is out of line with Hongkong’s fundamentals.”
