This article is republished from the chapter “CEO’s Letter” in the GIC Report FY2021/22. You may read the full report here.

The investment landscape is shifting rapidly. Profound uncertainties have emerged on multiple fronts. Years of concerns over deflation have turned into worries of elevated inflation, forcing economic policymakers to reverse stimulus policies. At the same time, the clock for the climate crisis is ticking, pandemic risk lingers on, and geopolitical conflicts and domestic political schisms are growing. There are no easy choices for policymakers and business leaders, and in turn, for investors.

GIC’s long-term performance has remained resilient. As at 31 March 2022, for the 20-year period from 1 April 2002, the annualised US$ nominal return of our portfolio was 7.0%. Adjusting for global inflation, the annualised 20-year real return stood at 4.2%.

The annual Net Investment Returns Contribution (NIRC) – which is derived from up to 50% of the investment returns from the Monetary Authority of Singapore (MAS), GIC, and Temasek Holdings – is a significant contributor to the government’s budget. For FY2022, the NIRC is an estimated S$21.6 billion.

A shift in the macroeconomic regime

The shift to a potentially high-inflation regime has significant investment implications. High inflation not only reduces real returns immediately, but its adverse impact on economic stability raises the risk premia on financial assets. Portfolio diversification will also be more challenging as few assets are spared from the effects of worsening inflation and slower economic growth.

While the increase in inflation caused by pandemic-induced supply disruptions and a strong recovery in demand should eventually fade, the reversal of the longer-term drivers of disinflation is concerning. Secular disinflationary forces in the last three decades, including productivity gains from the globalisation of labour and trade, favourable demographics, and the inflation-fighting credentials of central banks, are dissipating. Disinflationary tailwinds may be turning into inflationary headwinds.

Such a development would reverse the gains made in GIC’s first 40 years. GIC was founded in 1981 – a year when inflation in the US approached 10% and long-term interest rates were 14%. Through the next 40 years, inflation and interest rates saw a secular decline. While there were cyclical fluctuations along the way, each cycle witnessed lower peaks in rates during expansions and lower troughs during recessions. A portfolio that was invested fully in bonds would have returned 3.4% in real terms.

Today, with continued low interest rates, the same hypothetical portfolio is likely to earn just enough to beat inflation. Adding on riskier assets goes some way towards securing better real returns, but one must then contend with stretched valuations along with late-cycle dynamics that can impact profits. There are no straightforward solutions.

Advancing the low-carbon transition

The low-carbon transition is another major shift. Time is running out to take decisive action on climate change as highlighted by a series of reports published by the Intergovernmental Panel on Climate Change (IPCC) in recent months. A particular difficulty is the need to balance the trade-offs between the environmental and social impacts of the transition, especially in emerging markets.

Nevertheless, the low-carbon transition presents tremendous opportunities, as transition efforts are accelerating, and innovative sustainability solutions are emerging at scale. In the energy sector alone, capital needs will have to increase from US$2 trillion to almost US$4.5 trillion per year by 2050, according to the International Energy Agency (IEA). Investors and businesses can take advantage of these opportunities.

Changing political dynamics

Finally, both domestic and international politics continue to fragment. Income inequality is polarising countries around the world, while intensifying rivalries between key economies are contributing to an increasingly fractured global power structure. The ensuing political and policy uncertainties are making business and investment planning for the long term difficult. If this continues, the resulting frictions and the potential decoupling of the global economy will raise business costs and lead to higher investment risks as well as lower investment returns.

Responding to continued uncertainties

Transitions are difficult to forecast and attempts to predict a specific outcome are not always helpful. A scenario where the global economy experiences a hard landing that pushes us back to a low-growth and low-inflation world is not beyond the realm of possibility. Likewise, the cumulative effect of technological progress and recent advances in digitalisation could boost productivity and improve profitability, so a world of high-growth and low-inflation can also materialise. The outlook is exceptionally uncertain.

How is GIC responding to these challenges? We have doubled down on our core investment principles – a continued commitment to portfolio diversification, taking the long view, and the ability to prepare, not predict. As we navigate a world in flux, we remain clear about our strengths and limitations, and are ready to pivot as new challenges and opportunities arise. Engaging in alternative scenario planning is one example of how we proactively identify and mitigate our exposure to market vulnerabilities. In addition, we continue to step up active management to maximise our value-add, increase our investments in inflation-resilient real assets, and deepen our partnerships.

To drive the low-carbon transition, we not only actively invest in new technologies, such as green hydrogen, carbon removal and even nuclear fusion, but also engage with and support our investees’ transition efforts. We divest as a last resort. Ultimately, we seek to accelerate the decarbonisation of the real economy.

We are also strengthening partnerships with like-minded actors across both the public and private sectors to catalyse meaningful climate action and collaboration, and address challenges related to climate finance and regulation, as well as ESG data and standards. As an example, GIC, together with 12 members of the Asia Investor Group on Climate Change (AIGCC), joined the Asian Utilities Engagement Program in 2021 to support utility companies in Asia in their decarbonisation journeys. This is a crucial initiative given that Asian utilities account for almost a quarter of the world’s total carbon emissions.

In addition, we have established a dedicated Sustainability Office to continue advancing the holistic integration of ESG across our investment and corporate processes, and strengthen our research on critical sustainability issues.

Strategy, however, matters little without effective execution, and in execution, human talent is the key ingredient. We recognise the importance of developing a diverse and capable pool of talent that is committed to our purpose and aligned with our values, and we have dedicated the feature article of this year’s annual report to this topic.

Serving the needs of our communities and employees

As part of our wider purpose, we serve the interests of a wider group of stakeholders including the communities around us and our employees who are at the heart of delivering our mandate. Last year, in celebration of our 40th anniversary, GIC staff across all our offices came out in full force to care for the community through our environmental and social impact initiatives. We were heartened to see the bonds forged through our employee and community engagement programmes, such as Celebrate OneGIC and With Love, GIC, which we will continue beyond our anniversary year.

We are also excited to open our 11th office in Sydney this year, which signals our continued commitment to strengthening our international presence and partnerships.

In addition, I would like to express my heartfelt gratitude to our outgoing Chief Technology Officer, Ms Wu Choy Peng for her contributions to GIC in strengthening and scaling GIC’s data and technology infrastructure and capabilities.

Committing to investing with purpose and responsibility

Growing protectionism and distrust reduce cooperation and are especially detrimental to the collective actions required to tackle global challenges such as inflation, climate change, and geopolitical fragmentation.

GIC will continue to adapt to the changing realities while remaining anchored to our mandate, values, and investment principles. We remain committed to investing with purpose and responsibility, and to making a positive impact on the world and communities we operate in.