Modest and uncertain growth fundamentals
Besides high starting valuations, the fundamental outlook for assets is also subdued and uncertain. We anticipate three possible scenarios for the next 10 to 20 years. One scenario is that of a “back to normal” world, where over time the global economy and financial markets recover. Growth in the developed world turns out somewhat lower but this is offset by China and India, although all the major countries will be dealing with aging populations. In this scenario, interest rates will rise, though slowly, while equities will benefit from continued growth. We expect that over 20 years, taking into account both starting valuations and the fundamentals in this “back to normal world”, real annualised returns on global bonds would be 0-1% and that of global equities around 3%.
In the second scenario, the global economy is in “stagnation” for a long period of time. This may be triggered by a US recession, the Eurozone breaking up, or a China hard-landing. Regardless the cause, it will be much more difficult for central banks to maintain confidence. Political and social forces will also push for de-globalisation, resulting in trade and investment restrictions. These combined factors will trap the global economy in sub-par, mediocre growth for a long period of time. In such a world, we would expect bonds to perform better while equities suffer.
The third and last scenario is “stagflation”. This occurs because a combination of high debt, easy monetary policy, and populism eventually results in many countries tolerating higher inflation. Economic growth, however, does not improve. In this scenario, both bonds and equities would perform poorly.
How GIC invests in a low-yield, high uncertainty environment
GIC anticipates significantly lower and more volatile returns in the next 10 to 20 years, compared to our experience in the last two to three decades. Our key sources of return will remain the Policy Portfolio and the Active Portfolio. While our investment framework and approach remain sound, we will need to adjust some parts of our strategy as conditions change. We will continue to emphasise generating returns through a long-term, diversified and relatively conservative portfolio.
Most critically, we have to ensure that our portfolio does reasonably well in a range of plausible scenarios. This means the portfolio needs to be diversified along multiple dimensions (such as across different regions and return drivers), keep its overall risk within our tolerance threshold, and have a mix that allows us to harvest risk premiums over the long term. We will also continue to explore new asset classes and portfolio construction approaches.
For a number of years, GIC has focused on building a diversified portfolio of active investment strategies. Our investment framework guides us in allocating risk capital to strategies that are expected to add to overall portfolio returns. In the new environment we will continue to do so, and be even more vigilant as both risks and opportunities are likely to increase. In addition, we will strive harder to reduce portfolio costs as any such savings are direct additions to our portfolio returns.
Looking ahead, we expect a difficult investment environment with modest growth prospects, greater uncertainty and more volatility in the macro economy and markets. The long-term (20-year) returns are likely to be significantly lower than what we saw since 1980. Nonetheless, our investment philosophy, governance framework, organizational capabilities and market network, all carefully developed since 1981, leave us well-placed to invest in this new environment.