GIC's two winning strategies

The Government of Singapore Investment Corporation achieved a 20-year annualised real rate of return of 3.9 per cent for the period up to March 31. In its annual report released yesterday, GIC also offered further insight into its investment considerations. It discusses the merits of long-term investing and how it is practised in GIC.

Published The Straits Times, 1 Aug 2012

THE Government of Singapore has entrusted GIC with managing its funds for the long term. This allows GIC to adopt a long-term investment approach - maximising long- term returns while managing short-term market fluctuations.

Our long-term investing approach allows us to adopt two strategies that other investors may not be able to: harvesting returns from riskier assets and taking contrarian stances when markets are at extremes.

Harvesting returns

IN THE long term, riskier asset classes should deliver better returns in order to compensate investors for taking on more risk. By investing in risky assets, investors trade off uncertain payoffs for potentially higher returns over time.

We call the extra return earned for investing in a risky asset the asset's risk premium.

It takes patience to harvest risk premiums because the extra returns accumulate slowly and unpredictably over time, but GIC's long-term investment approach allows us to do so.

Possibly the most important risk premium in financial markets is the equity risk premium (ERP). The ERP is the additional return that stocks deliver over the risk-free rate earned from longterm treasury bonds. This extra return compensates investors for taking on the higher risk of the equity market.

While investors may disagree over the exact definition of the ERP, most do not dispute that it exists. Historically, the global ERP has been around 4-5 per cent.

Apart from the ERP, risk pre-miums have also been observed in other asset classes. Bonds, which represent long-term loans, offer a higher interest rate than short-term deposits to compensate for the risk that interest rates might change.

Real estate and private equity, which are less liquid and more difficult to trade, also offer higher returns to compensate for the additional risks.

The Government's portfolio has a significant exposure to equities and equity-related asset classes as shown in Chart 1. These asset classes offer access to the attractive long-term ERP and other risk premiums.

Our long-term investment horizon allows us to harvest these risk premiums while accepting short-term price fluctuations. Over time, these risk premiums compound into superior portfolio returns.

As shown in Chart 2, even though global equities fell substantially during the dot.com crisis (2000-2003) and global financial crisis (2007-2009), staying the course and harvesting the ERP would have led to positive returns over cash and bonds.

Since it is difficult for a large investor like GIC to time market falls and rises, GIC accepts some short-term setbacks to achieve our long-term investment goals.

Another example of a risk premium that GIC has harvested is the emerging market risk premium. Emerging market assets are more volatile than developed market assets in the short term. Emerging markets may also be riskier in other respects, such as presenting a higher probability of fraud, loan default and lower tradability during periods of market stress.

Despite the greater risks, GIC decided to increase our exposure to emerging market equities in 2003. This decision was based on two beliefs.

First, the boom-and-bust cycles that plagued emerging markets in the past would be less severe in future because emerging markets' governments and companies have strengthened their governance frameworks.

Second, and more importantly, these structural improvements in emerging economies would be sustained. Hence, GIC took the view that emerging markets would outperform developed markets in the long term.

Since 2003, GIC has built up its exposure to emerging market equities to 15 per cent of the portfolio, with a concentration in emerging Asia.

Emerging market Asian equities have returned 127 per cent since 2000, whereas developed market equities have returned only 22 per cent over the same period.

Contrarian stance

A STRATEGY of harvesting long-term risk premiums does not mean that investors should simply buy financial assets and wait. The prices of potential investments often do not reflect their true, fundamental value. For example, investors bid up technology stocks during the late 1990s, leading to the dot.com boom that eventually collapsed. On the flip side, recessions often drive many investments to bargain prices. These deviations from fundamental value are often caused by short-term market sentiment and herd behaviour - irrational urges that an astute investor should not act on.

Some of these deviations may also be amplified by investors' circumstances, for example, investors who use investment returns to fund regular payouts may have to sell assets during a crisis to raise cash because returns have become zero or negative.

As a long-term investor, GIC has the flexibility to take a contrarian stance, taking positions against the crowd when markets deviate significantly from fair value. Because GIC's performance is assessed over the long term, and the portfolio does not face regular large withdrawals, we can accept possible short-term underperformance against our expectations in return for longer-term gain.

GIC attempts to determine the intrinsic value of our investments. GIC buys assets when their prices are below intrinsic value and sells them when they are expensive.

This is not easy because markets generally function well, but one such episode occurred during the global financial crisis of 2008.

Conclusion

GIC's long-term investment horizon is a competitive advantage which should continue to be exploited to produce better returns for the Government's portfolio.

Long-term investing enables GIC to harvest risk premiums from different asset classes. It also allows us to take a contrarian stance when short-term deviations are extreme and prices are significantly away from their long-term fundamentals. But we can enjoy the rewards of long-term investing only if we are prepared to tolerate short-term losses or underperformance relative to market indexes from time to time.

GIC's real rate of return over 20 years steady at 3.9%
Positive returns from real estate and bonds help boost performance
By Alvin Foo, The Straits Times, 31 Jul 2012

THE Government of Singapore Investment Corporation (GIC) achieved a steady 3.9 per cent annualised real rate of return over a 20-year period, despite increased market turbulence.

It means that over a 20-year period up to March 31, the Government's fund manager has generated a return averaging 3.9 per cent a year on top of having protected its portfolio value against global inflation.

The previous year's annualised 20-year figure was also 3.9 per cent. In nominal US dollar terms, the return was 6.8 per cent.

The main aim of GIC, which manages more than $100 billion of Singapore's foreign reserves, is to achieve good long-term returns for the Government, above the rate of global inflation.

GIC's group president Lim Siong Guan noted "the market experienced many twists and turns over the last year", given the euro zone debt crisis, United States economic slowdown and uncertainties in emerging markets.

GIC's group chief investment officer Ng Kok Song said positive returns from bonds and real estate made up for the negative returns from emerging markets and natural resource equities.

GIC also provided its rates of return over shorter time frames such as five and 10 years.

Over five years, it returned an annual nominal US dollar rate of 3.4 per cent - down from 6.3 per cent last year. Over 10 years, it posted 7.6 per cent yearly, up from 7.4 per cent last year.

GIC's five-year and 10-year returns beat two composite portfolios, despite taking less risk. But the 20-year nominal return was lower as in the first decade GIC invested conservatively in cash and bonds. The composite portfolios were a 60:40 mix of global equities and global bonds and another with a 70:30 mix. Such a mix would be representative of the holdings of pension funds and sovereign wealth funds.

GIC's portfolio mix saw some changes. Its cash allocation rose from 3 per cent to 11 per cent as it "allowed the cash inflow from investment income and fund injection to accumulate during the year in preparation for better investment opportunities", said Mr Ng. Exposure to public stocks fell from 49 per cent to 45 per cent.

The portfolio's geographical distribution was broadly unchanged, with Europe's share down from 28 per cent to 26 per cent and Asia up from 27 per cent to 29 per cent.

GIC's exposure to the troubled economies of Portugal, Ireland, Italy, Greece and Spain was 1.4 per cent on March 31. This was invested largely in real estate and selected equities in Italy and Spain.

On the outlook, Mr Ng said: "Investment returns are likely to be low until the global economy returns to balanced and sustainable growth." He said the winding back of debt in developed economies will hinder growth.

"The emerging economies led by China will have higher and more robust growth, but are not yet of a sufficient scale to offset anaemic growth in the developed economies," Mr Ng added.

Market experts said GIC's returns were fairly decent, given the tougher conditions this year.

CIMB regional economist Song Seng Wun said: "They just about kept their heads above water, in very choppy waters."

Hedge fund Ferrell Asset Management's managing director David Lee said: "With inflation close to 4 per cent to 5 per cent, it's getting harder to find instruments to beat that."

Earlier this month, Temasek Holdings also released its annual report. Its 20-year annualised total shareholder return - the return to its shareholders as if it held the portfolio directly - was 15 per cent.

Long-term view reaps returns, says GIC
Latest annual report gives peek into strategy, role of hired fund managers
By Alvin Foo, The Straits Times, 31 Jul 2012

THE Government of Singapore Investment Corporation's (GIC) long-term horizon gives it an edge over other investors, it said in its latest annual report.

Taking the longer-term view enables GIC to harvest returns from riskier assets and enables the fund to take a contrarian stance when markets are at extremes, it added.

However, it must be prepared to endure short-term losses or underperformance compared with market indexes sometimes.

GIC group president Lim Siong Guan said: "This year, our report offers specific insights into GIC's investment considerations."

The report includes two articles which explain how GIC invests with a long-term horizon, and how it selects external public market fund managers.

Riskier asset classes should deliver better returns in the long term to reward investors for bearing more risk. The extra return is the asset's risk premium, said GIC. It added: "It takes patience to harvest risk premiums because the extra returns accumulate slowly and unpredictably over time, but GIC's long-term investment approach allows us to do so."

One example was its decision to raise its exposure to emerging market equities in 2003.

Since 2003, GIC's exposure to the more risky sector has reached 15 per cent of its portfolio with a concentration in emerging Asia.

This has paid off. Since 2000, emerging market Asian equities have returned 127 per cent while developed market stocks returned only 22 per cent in that time.

Being a long-term investor also offers GIC the flexibility to take positions against the crowd when markets deviate significantly from fair value, it said.

GIC is able to stomach short-term underperformance against its expectations in return for longer-term gain. This is because its performance is assessed over the long term and the portfolio does not face regular large withdrawals. It added: "GIC buys assets when their prices are below intrinsic value and sells them when they are expensive."

GIC also explained how it chooses and handles its external public market fund managers to whom it gives investment mandates. It noted that such managers have played a significant role, handling up to 20 per cent of the portfolio at times.

This approach "diversifies the Government's portfolio, expands the investment opportunities available and deepens our understanding of financial markets".

A total of 58 per cent of its external managers are based in North America, with 22 per cent in Europe, 11 per cent in Singapore and the remaining 9 per cent in Australasia. GIC said it uses a four-step process, involving strategy research and manager sourcing, manager review and due diligence, portfolio construction, and portfolio monitoring and risk management, to oversee its externally managed portfolio.

"We look for external managers who can maximise a portfolio's total market value over market cycles while controlling the interim risks," it added.