GIC’s mandate is to achieve good long-term returns. The primary metric for evaluating GIC’s investment performance is the rolling 20-year real rate of return. The goal is expressed in real terms because GIC must, at a minimum, beat global inflation and preserve the international purchasing power of the reserves placed under its management.
Over the 20-year period that ended 31 March 2016, the GIC Portfolio generated an annualised real1 return of 4.0% (Figure 1) above global inflation. In nominal USD2 terms, the portfolio generated an annualised return of 5.7% over the 20 years that ended 31 March 2016. This means that US$100 invested with GIC in 1996 would have grown to US$303 today.
GIC reports its performance as an annualised 20-year real return, which is the average time weighted portfolio return over that period. It is a rolling return, which means that last year’s 20-year return covers the returns from 1996 to 2015, this year’s 20-year return covers 1997 to 2016, and next year’s return will cover 1998 to 2017. For each new year added, the earliest year is dropped out. The change in the rolling 20-year return from year to year is therefore determined by what is dropped from the earliest year and what is added for the latest year (see Figure 2)
As an illustration of how the 20-year rolling return is affected by years being added and dropped as the window moves, consider the nominal returns of MSCI World Index. Global equities enjoyed high returns in the second half of the 1990s leading up to the tech bubble in the early 2000s, but low returns in the past two years following the Global Financial Crisis in 2008-2009. Consequently, the 20-year rolling return for global equities has been declining as shown in Figure 3.
This works in the other direction as well. When the years with unusually low returns such as in the Global Financial Crisis drop out, we would expect the rolling return to improve if the new years that are added have higher returns.
A long-term investment approach offers several advantages. It allows GIC to be contrarian in the face of short-term market movement and so reap higher long-term returns. For example, during market downturns, our active strategy teams are able to capitalize on our extensive networks, internal capabilities, collaboration and deal execution abilities to seize idiosyncratic investment opportunities with the potential for attractive returns. The illiquid and long-term nature of private equity and real estate investments also allows GIC to extract returns for bearing the illiquidity risk.
GIC’s long-term performance reflects three main factors. First, the dynamics of the global economy. Second, the performance of various asset classes, which we capture via our asset allocation strategy. Third, the performance of skill-based strategies undertaken by the various active strategy investment teams. The GIC Portfolio’s returns are largely driven by the first and second factors, which are captured by the Policy Portfolio. To supplement these returns, we add on the third factor – active strategies, which seek to outperform the Policy Portfolio by investing differently from the market benchmarks. Based on the risk parameters set by the client, we strive to optimise the GIC Portfolio to achieve the best possible long-term returns for a variety of economic scenarios. Our investment approach, including the investment framework implemented in 2013, is elaborated in the chapter on ‘Managing the Portfolio’.
Investors traditionally have regarded risk as the volatility (or standard deviation) of a portfolio’s returns due to fluctuations in market variables like asset prices, interest rates and exchange rates. While volatility is important, it does not adequately capture the risk of large losses. While small profits and losses typically reflect short-term swings in market sentiment, large losses may mean fundamental changes that could inflict long-term impairment to the portfolio.
The risk of large losses is often associated with market crashes. For instance, a portfolio consisting of 65% global equities and 35% global bonds would have experienced large losses over the short to medium terms during periods of market stress such as the Global Financial Crisis.
GIC maintains a diversified portfolio that is robust across a whole range of scenarios; taking on higher risks must be justified by higher expected returns. Through forward-looking risk analyses (involving stress-testing and scenario analyses), GIC’s portfolio is managed to maximize expected return, while minimizing the likelihood of large losses that may lead to permanent impairment. GIC’s long-term focus and contrarian investment approach – buying when most investors are selling due to their short-term concerns; and selling when most investors are buying again due to their short-term perspectives – allow us to look beyond the immediate short-term risks, and focus instead on the investments’ long-term return potential.
Each asset class carries a different risk profile. Growth assets such as equities generate higher returns, but also come with higher risk. Defensive assets such as sovereign bonds offer lower returns, but have lower risk and protect the portfolio in market downturns. Because the future is uncertain, the GIC Portfolio is constructed to be resilient across a broad range of plausible economic conditions, and still reap good long-term real returns. The GIC Portfolio is made up of a diversified range of asset classes, to benefit from the way different assets respond to possible market and economic conditions.
Table 1 and Figure 4 show the asset mix and geographical distribution of the GIC Portfolio as of 31 March 2016.
|Asset mix||31 March 2016 (%)||31 March 2015 (%)|
|Developed Market Equities||26||29|
|Emerging Market Equities||19||18|
|Nominal Bonds and Cash||34||32|
In the current state of the world economy, the task of diversifying has become harder as different financial assets have become more closely correlated. We nonetheless believe that a diversified asset mix puts us in better stead to benefit from changing market cycles.
The GIC Portfolio is constructed to deliver good long-term real returns. It is expected to perform better than the Reference Portfolio over the long-term, but it may underperform over shorter periods. GIC focuses on the long-term 20-year real return. The shorter 5-year and 10-year real returns are reported as intermediate markers, not as performance measures.
Table 2 shows the performance of the GIC Portfolio alongside the Reference Portfolio3 and looks at investment returns in the context of risk as defined by annualised volatility.
GIC’s 20-year nominal return was 5.7% per annum in USD terms, while that of the Reference Portfolio was 6.0%. This reflected the lower risk-orientation of the GIC Portfolio during the early years of the period, with as much as 30% in cash until the end of 1990s, resulting in lower returns than the Reference Portfolio. GIC’s lower risk profile over the 20 year period as a whole is indicated by the lower volatility of the portfolio at 9.2%, while that of the Reference Portfolio was 11.0%.
The GIC Portfolio returned 5.0% per annum in USD nominal terms over the 10-year horizon, while the Reference Portfolio returned 4.8%. In the last decade, GIC significantly increased its exposure to alternative asset classes such as real estate and private equity. In addition from July 2007 to September 2008, we reduced our public equities exposure by more than 10%, as we were concerned that equities had become overvalued in the euphoric market environment of early 2007. This contributed to the performance of the GIC Portfolio.
|Time period||Annualised nominal return4 (USD) for period ended 31 March 2016||Annualised volatility for period ended 31 March 2016|
|GIC Portfolio||Reference Portfolio||GIC Portfolio||Reference Portfolio|
Over the last 5-year period, the GIC Portfolio returned 3.7% per annum in USD nominal terms, lower than the Reference Portfolio. In the last 5 years, developed market equities, especially those in the US, have done particularly well. The GIC Portfolio held less developed market equities, hence had lower returns than the Reference Portfolio over the 5-year period.
GIC invests for the long term. To generate good real returns over the long term, we have to be prepared for short-term underperformance relative to the market indices, even for several years at a stretch. For instance, we have more emerging market equities than the Reference Portfolio because we have assessed that emerging market equities will benefit from the sustained structural improvements in these economies, and contribute positively to the long-term real returns of the GIC Portfolio. We have maintained this assessment even though emerging market equities have underperformed developed market equities in recent years.3. The Reference Portfolio was adopted from 1 April 2013, and reflects the risk that the Government is prepared for GIC to take in its long-term investment strategies. It comprises 65% global equities and 35% global bonds. For more details, please refer to the chapter on ‘Managing the Portfolio’
Prospects for returns on assets are not as good as what we saw from the 1980s to the 2000s. We expect real returns for both the GIC Portfolio and Reference Portfolio to be lower, due to the all-time low interest rates, modest global growth prospects and high valuations of financial assets.
Complicating the prospects for returns is a more uncertain outlook for economic growth. High debt levels in both developed and emerging countries weigh on growth and undermine the effectiveness of macroeconomic policies. Other risks to the growth outlook include rising income inequality, populism, geopolitical tensions and the potential negative impact of disruptive technologies. Rising populism could generate more protectionist policies. Public sentiment against globalization and foreign investors could grow and affect global investors like GIC. Technological change has been accelerating, but it is not clear if and when it will translate to significantly higher productivity growth in the economy, and whether it will cause serious structural unemployment. Technological progress poses both risks and opportunities for investors. On the one hand, disruptive technologies can hurt existing investments, but on the other hand, new companies and opportunities will rise with innovation.
A more difficult macro environment will separate investors with the skills and network to find attractive bottom-up investment opportunities, from those who do not. GIC continues to build on our extensive range of capabilities and network of business partners, enhance our investment and risk management processes as well as look for new ways to get the most out of our knowledge and data resources. What is most important for GIC is to continue generating a good real return over the long term, while paying due attention to risk and opportunity.