The one thing that tiny Singapore has global scale in is the sheer size of its national savings, which play a crucial role. Managed principally by GIC and Temasek, these savings provide Singapore with a buffer against extreme emergencies — the large government support schemes during the Covid pandemic were an example of this. The returns from those savings have also become a very large contributor to the government’s Budget. Thus, preserving those savings and ensuring a good return from them are vital to Singapore.
Regrettably, the more troubled world we are living in means that financial markets now operate under a new asset pricing regime which makes preserving wealth and generating decent returns far more challenging than in the past 40 years. Those years saw falling bond yields boost valuations while globalisation and China’s super-charged development provided huge opportunities for companies to build earnings. These strong tailwinds to investors are unlikely to be repeated. That means Singapore needs to re-think its model for managing its vast pool of savings, right down to basics like how its investment management institutions are structured, what mandate they are given and how their performance is measured.
A troubled world re-shapes the asset pricing regime
To put it succinctly, the global environment today is marked by great uncertainty: there is so much about critical factors affecting investors that we simply do not understand very well anymore. In addition, there are other factors that we know but which are probably negative for investment returns.
Take greater uncertainty first. Investors can deal with risk, which refers to the dangers which can be quantified in terms of probabilities because there is good enough historical experience that can guide us. But what we are dealing with today is not risk but uncertainty — where there are many “unknown unknowns”, many unexpected developments with unpredictable outcomes with probabilities that cannot be estimated even roughly.
Just look at the recent past and observe how often the market consensus on basic economic and political issues turned out to be completely wrong. In the past two years, the brightest minds in central banks substantially under-estimated inflation, which meant that monetary policy was mis-calibrated. Then high interest rates were supposed to have triggered recessions in the US and other developed countries, but that did not happen. The Chinese economy was supposed to have enjoyed a nice bump after its government relaxed pandemic restrictions at the end of 2022, but we are still waiting for that to materialise. There seem to be changes in consumer psychology and business confidence that policymakers and analysts do not fully understand.
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In short, rapid changes in political, economic, technological, demographic and climate structures have upended the models we used to understand the world of investing. As we look into the future, we find several mega trends that will make for greater uncertainty:
- Shifting geopolitical realities explain part of this uncertainty. Few expected the Russian invasion of Ukraine in February 2022 nor the outbreak of hostilities in the Middle East on Oct 7 last year. We can see pressures building up for wider confrontations in the Middle East but how those will play out is unknowable. The same can be said of potential threats in the Korean peninsula and elsewhere.
- Demographic pressures are also building up whose effects are hard to predict: populations in rich countries are declining while desperately poor areas of Africa, the Middle East and South America are still seeing their numbers grow. The result is a surging desire among the poor to emigrate to those rich countries, which then creates all sorts of political and economic problems.
- Then there is climate change — we are still learning about this so that adds yet another layer of uncertainty. We are already seeing the consequences in the form of weather-related shocks. But these are difficult to model and so we do not know how severe the impacts will be over time. In addition, there will be an energy transition, away from fossil fuels towards renewables: again, how that will evolve is something we can only guess.
- Technological advances are adding to the confusion — we know that artificial intelligence will change things dramatically but the jury is out on which sectors will be affected, which companies will be winners or losers and what the full economic and social consequences will be.
- Other fundamentals that we took for granted are also poised to change. For example, can the US dollar sustain its dominance given America’s diminished geopolitical standing and worsening public debt and balance of payments underpinnings?
Already, there is a direct result for markets and investors. Some of the simple rules that financial investors used to forecast turning points no longer seem to work. An example is how the yield curve inversion (when short-term rates exceed long-term ones), which used to predict recessions, no longer works. The world around us is shifting but we do not have a good compass to guide us around this new world.
Second, apart from the shocks that uncertainty will cause to markets from time to time, it also appears that the drivers of valuations and earnings or cash flows will also change:
- There will be fewer gains from globalisation as it morphs into “slowbalisation” or maybe even de-globalisation. Since the early 1980s, the phenomenal growth of trade, capital flows and people unleashed immense synergies that promoted growth and underpinned good investment returns. But today’s world is rife with rising protectionism that is slowing the expansion of world trade. Countries are turning inward as well, pursuing industrial policies that favour domestic producers over foreign ones.
- The world will no longer have the huge growth in China as an engine of global growth. China’s slowing demographics and the imbalances in its economy will limit its dynamism. Although India’s growth is set to improve, we do not see it able to replace China.
- Politics and policies may be less friendly to corporate earnings and expansion. There are growing pressures for income redistribution following the sharp rise in the profit share of global incomes in recent decades. Governments are responding with higher taxes and are also drafting regulations to rein in what they see as excessive corporate power.
- After a long period of benign inflation which allowed interest rates to remain low, we are likely to see prices rise at a faster pace —which means that interest rates will be higher on average. Higher rates tend to depress asset valuations, and so are a negative for returns.
- There is likely to be continued financial volatility. The recent few weeks have reminded us of how asset prices can swing wildly. So long as there is the tendency for herd behaviour, we will continue to see such swings. In addition, the long period of ultra-low interest rates after the 2008 financial crisis has probably created imbalances in the financial system which then erupt as stresses every now and then — as we saw with the near- meltdown in the UK gilts market in October 2022 and the collapse of American regional banks in March last year.
In other words, the prospects for investment returns will be hurt by such changes in earnings and valuations.
So, what needs to be done?
Such big changes suggest that we need to review the fundamentals of our approach. There are a few questions we need to ask.
- What should GIC manage? Currently, it manages several separate pools of savings — the cash surplus from the Central Provident Fund, the accumulated budgetary surpluses of the government and the excess foreign exchange reserves of the Monetary Authority of Singapore. Each represents a very different “client” with very different risk-reward tolerances and time horizons. Yet the whole lot is managed as one pool — is this right at a time of immense investment challenges where different pools of savings with varying risk-reward trade-offs and different time horizons are involved?
- Should Temasek’s multiple roles be simplified? Currently, it seems to have several. First, Temasek oversees strategic national government-owned companies, which are not actively managed for high returns in the way that a conventional fund manager approaches it. Companies such as PSA which runs our port infrastructure, DBS Bank, Singapore Airlines
Conclusion
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Singapore has had a good run since GIC was set up in 1981 and since Temasek was restructured in 2004. Both have matured into highly respected institutions, underpinned by sound processes, highly competent managers, and generally good corporate governance. This was evident in the latest annual reports of the two sovereign wealth funds. Returns on investment in the long term have exceeded the hurdle rates given to them.
Some observers do say that returns are lower compared to this or that benchmark that they choose. But performance has to be assessed on the basis of the mandate that is given to investing institutions by its “client” which is the government. For example, the mandate given to GIC is a conservative and risk-averse one. If risk tolerance is low, then it follows that returns will be commensurately lower. Based on the mandate it is given, returns on investment have been more than decent.
The question is, therefore, about the future. Given the immense changes in the investment environment that are unfolding, one can rightly question whether what worked well in the past few decades will still work well for Singapore. Thus, it might be timely for a holistic review of how national savings will be managed in the decades to come.
Manu Bhaskaran is CEO of Centennial Asia Advisors
