Temasek Holdings and GIC have released their annual reports in the past week, so it is a good time to take a step back and think about how they have been doing. One issue is, of course, their financial performance, which continues to be good and well ahead of their respective mandates. But there is an overarching issue that is more important and deserves a deep review — is the overall management of Singapore’s national assets structured optimally?
Have Singapore’s sovereign wealth funds delivered good returns for the risk they take?
Before we look at this, it is really important for us to understand the notion of risk-adjusted returns. A fund can always reach for high returns by taking on a lot of risk but that may not be what it is mandated to do by its clients. Returns must be viewed in the context of the risks taken — if clients prefer a less risky approach, they have to be satisfied with lower returns. A fund should not be marked down because its returns are lower than another fund that is allowed by its clients to take on a lot more risks.
In this context, Singapore’s sovereign wealth funds have done well, delivering good returns over the long term, given the different risk profiles that they are allowed to take. GIC, for instance, has a mandate to “preserve and enhance the long-term international purchasing power of the reserves” under its management. It is required to take a conservative approach to risk, and so its returns must be assessed differently from the way Temasek’s are, since Temasek is allowed to take more risks. It should not be compared with the sovereign funds of other countries either, since those other countries may give more leeway to their sovereign wealth funds to take risks. GIC has delivered an average return of 3.4% in US dollars above inflation over the 20 years to March, not an easy task to have achieved. That is by any measure a good performance, especially given the highly conservative structure of their portfolio.
Similarly, Temasek has performed well, too. Temasek uses different metrics to measure its performance, and its mandate is different from GIC’s, so it cannot be compared like-for-like with GIC.
Temasek’s aim is to maximise shareholder value over the long term, and it has largely done so. Temasek has delivered a total return in Singapore dollars of a relatively high 7% a year over the past 20 years.
Just as important as the bottom-line measure of performance is the question of the investment processes that allow such returns to be generated over a long period of time while ensuring that the risks of the portfolio are well managed. Both GIC and Temasek have investment processes in line with their global peers, with appropriate internal checks and balances, and which are audited rigorously.
So, their good performance over a long period of time is real and not made up. Singaporeans can rest easy; the scare stories in some social media sites of sustained and massive losses in GIC and Temasek are just that — they have no basis in fact.
Why do we need to think more rigorously about management of savings?
If the returns in the past have been good, the next question is: What about the future? There are several reasons why the time may have come to rethink how Singapore has been managing its surpluses.
First, the global environment is becoming more disturbed by geopolitical, economic, technological and climate changes, many of which are inherently unpredictable. This makes for a world that is marked not so much by quantifiable risks but more and more by unquantifiable uncertainty. In this context, a savings structure that worked well before may not work as well in future.
Second, Singapore is also changing. One big issue is the growing demands for social security expenditure, which will have to be funded either by taxation or by a higher contribution from the investment returns of our sovereign wealth funds. If a larger proportion of the budget has to be funded by such investment returns, then it becomes more important that we have a structure that maximises returns while containing risks. Otherwise, there may be years when we have a large hole in the government budget. Also, if we can confidently expect higher returns, then it may become less necessary to raise taxes such as personal income tax or the goods and services tax. Another issue we should think about for the longer term is political change — there is no guarantee that we will have the kind of political system that supports rational investment for the national interest in the future. That raises the question of whether the current structure best protects the management of our national savings should something go wrong politically.
So, is the structure of our savings management good enough for the future?
The first step is to appreciate what assets are being managed by the government. There is a range of them:
• First, the core state enterprises, such as Singapore Telecommunications, DBS Bank Group Holdings, Singapore Airlines and Singapore Technologies Engineering. The government will retain ownership in them for a long time for various strategic reasons. Whether their stock market performance is likely to be good or bad over the next few years, Temasek will retain its ownership and not divest or invest more, in line with expectations for returns.
• Second, enterprises that are majority-owned by Temasek but may not be strategic. For instance, some of these assets could be divested if expectations for market returns become pessimistic. Or they can be sold down to raise funds for Temasek to undertake strategic investments whose purpose may not be to maximise financial returns but to achieve an economic development objective.
• Third, the Central Provident Fund (CPF) monies, which are transferred indirectly via government mechanisms to GIC to manage.
• Fourth, the government’s own surplus funds, arising from its years of budget surpluses as well as the proceeds from land sales and sales of government securities.
• Fifth, foreign exchange reserves, which the Monetary Authority of Singapore needs to defend the Singapore dollar. These have to be managed very differently from the other funds, since they need to be highly liquid as they can be called upon at any time.
• Sixth, the land that the Singapore government owns, said to be about 85% of the total land area of the country.
This survey of the range of assets that are being managed raises several important questions.
First, what should be the objective of managing these assets? Should it be purely a financial objective or should there be a strategic or an economic development dimension in some cases, which takes priority over narrow financial ones?
• For instance, should land assets be managed to maximise financial returns only? Or should they be managed with other considerations such as ensuring that property prices do not surge and undermine our competitiveness as well? Currently, it does seem that the financial objective is given substantial priority.
• Another example is Temasek: Should it or a separate fund have a strategic objective — of making investments to further economic development while sacrificing immediate financial returns? For example, if Singapore wants to develop new industries — as we did in the 1960s — these will take time to deliver any return, and there is a high chance of failure in some of those ventures.
Second, given the range of assets and their varying objectives, should there be separate funds managing each set of assets?
• Take the CPF monies currently managed by GIC. As these represent the retirement funds of our individual Singaporeans, they should be managed with great care and with a time horizon that matches that of the average CPF member. It would make more sense for these funds to be managed differently. In most countries, there are pension funds or similar funds that collect the savings for retirement and then allocate them in a rigorous manner to a diverse array of fund managers. This has worked very well, for example, the Superannuation funds in Australia.
• Or take the core corporate assets under Temasek: It seems strange to commingle these assets with other assets that Temasek manages, since these are being managed for custodial reasons rather than to maximise returns.
• Similarly, the government surpluses from land sales and fiscal surpluses are distinct from the CPF monies, so they should be managed with a very different risk profile as well as time horizon compared with the CPF monies. Does it make sense to mix these monies with CPF monies in one agency as is the case now?
Third, and this is very important, what is the best way to manage risks to the surpluses when a nation has a very large pot of such surpluses? The exact size of GIC’s funds is a secret that very, very few individuals have access to. There are several problems with this approach:
• First, is it appropriate to place the bulk of Singapore’s surpluses in one institution called GIC with very little transparency as to the size of the assets, its asset allocation and its holdings? The system has worked well for now because we had a political system with integrity, so we avoided criminal misuse or wastage of the funds, or a situation where a dominant leader could instruct that the monies be invested in some kooky scheme. It works well also because the leadership team and staff at GIC are people of extraordinarily high integrity and professionalism. But can we be sure that such a system will always be there? Is it not better to have a system with several large funds and managed with much greater transparency — and should we not have such a system implemented now when we have a sound political system and things are working well?
• Second, some analysts argue that there could be diseconomies of scale. When a fund becomes too large, its individual investments have to be of a certain minimum unit size that could still move markets, which could prove troubling for the fund. Such huge funds also tend to lose nimbleness and flexibility as they grow ever bigger. This is why many well-known hedge funds will not take new funds beyond a certain size. Even if their management appreciates this risk and tries hard to avoid the downsides, the fact is that large organisations have to be bureaucratic in order to be run smoothly and efficiently — but that would almost certainly have a negative impact on return performance.
In fact, most other countries do aim to have divergent funds managing their assets; very few place all their eggs in one basket. Take Sweden for example. It now has five separate funds to manage its retirement savings. The funds operate independently of each other or of any supervising agency. They also compete against each other and formulate divergent investment policies and corporate governance structures, while adopting different approaches to risk management. The system seems to have worked well.
In short, Singaporeans should be happy with the performance of their sovereign wealth funds. What they should be thinking about is the structure of managing the country’s immense financial reserves — here, there does seem to be a case for a substantial rethink.
Manu Bhaskaran is a partner and head of economic research at Centennial Group Inc, an economics consultancy. He has done consultancy work for both GIC and Temasek.