GIC’s mandate is to achieve good long-term returns above global inflation. This is represented by the primary metric for evaluating GIC’s investment performance – the rolling 20-year real rate of return. GIC’s goal is to beat global inflation, and preserve and enhance the international purchasing power of the reserves placed under its management.
Over the 20-year period that ended 31 March 2018, the GIC Portfolio generated an annualised real1 return of 3.4% (see Figure 1). In recent years, GIC’s rolling 20-year return has been fluctuating around 4% but has declined below that level in the last two years. Returns in most recent years have been good. However, the high returns from the beginning of the tech bubble period in the late 1990s have dropped out of the 20-year window, while the post-tech bubble declines have remained in the window (see ‘Understanding the Rolling 20-Year Return’). We expect this effect to continue for a few more years, dampening the rolling 20-year return.
1 An annualised real return is the return adjusted for global inflation. The real return number is independent of the currency used to compute it.
Investment returns are inherently cyclical and volatile even over 20 years. For example, the 20-year real return for a US 65% equity and 35% bonds portfolio was below 2% in the 1980s, but as high as 10% in 2000. The average 20-year return of a US 65% equity and 35% bonds portfolio was 5.1% over the period from 1900 to 2018.
Understanding the Rolling 20-Year Return
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 spans the period 1998 to 2017, this year’s 20-year return spans 1999 to 2018, and next year’s return will span 2000 to 2019. 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 the returns from the earliest year that drops out and what is added for the latest year (see Figure 2).
Figure 2: Illustration of a Portfolio’s Rolling 20-Year Return
GIC’s long-term performance is largely driven by the dynamics of the global economy and our asset allocation strategy as reflected in the Policy Portfolio. This is complemented by the performance of skill-based strategies undertaken by active strategy investment teams, seeking to add returns above market benchmarks. In aggregate, we strive to achieve the best possible long-term returns for the GIC Portfolio across a variety of economic scenarios, within the risk parameters set by the Client. Our long-term investment approach is elaborated in ‘Investment Approach’ and in the chapter on ‘Managing the Portfolio’.
GIC’s long-term investment approach has a few key features. It allows us to earn risk premia from exposure to systematic risk factors, such as the equity risk premium. It also allows for investment in illiquid asset classes such as private equity and real estate, which offer the prospect of better returns. Exposure to these risk premia enables GIC to harness the power of compounding over time.
In addition, adopting a long-term approach allows GIC to avoid the drawbacks of pro-cyclicality. GIC focuses on long-term fundamentals and value rather than on short-term market price gyrations. This reduces the chances of overpaying at market tops or underinvesting at market bottoms. Long-term investing is not a rigid buy-and-hold approach. GIC’s long-term value investing approach distinguishes price from value. If an asset’s price persistently exceeds its fundamental value, we would tend to sell, and conversely, even if it sometimes means going against current market sentiment.
The GIC Portfolio is a well-diversified portfolio of asset classes. Each asset class carries a different risk and return profile. Growth assets such as equities generate higher returns, but are riskier. Defensive assets such as sovereign bonds offer lower returns, but have lower risk and protect the portfolio in market downturns. As the future is uncertain, the GIC Portfolio is constructed to be resilient across a broad range of plausible market and economic conditions, while generating positive long-term real returns.
Table 1 and Figure 3 show the asset mix and geographical distribution of the GIC Portfolio as of 31 March 2018.
|Asset Mix||31 March 2018 (%)||31 March 2017 (%)|
|Developed Market Equities||23||27|
|Emerging Market Equities||17||17|
|Nominal Bonds and Cash||37||35|
While asset allocation is our primary focus in portfolio construction, we also monitor our exposures across countries.
While the GIC Portfolio is constructed to deliver good 20-year returns above global inflation, we monitor its ongoing intermediate investment performance. Table 2 shows the nominal USD returns over 10 years and 5 years and the corresponding portfolio volatility. We include 20-year nominal numbers for completeness here.2
|Time Period||Nominal Return3||Volatility4|
2 GIC’s primary metric is the rolling 20-year real rate of return, which we described earlier in this chapter.
3 The GIC Portfolio’s rates of return are computed on a time-weighted basis, net of costs and fees incurred in the management of the portfolio.
4 Volatility is computed using the standard deviation of the monthly returns of the GIC Portfolio over the specified time horizon.
The GIC Portfolio’s 20-year real return was 3.4%, or 5.9% per annum in nominal USD terms.
Over the 10-year period ending March 2018, the GIC Portfolio returned 4.6% per annum in USD nominal terms. This period includes the poor market performance due to the Global Financial Crisis and the European Debt Crisis, and the subsequent recovery due to the aggressive monetary policy interventions.
Over the last 5-year period, the GIC Portfolio returned 6.6% per annum in USD nominal terms, benefitting from the run-up in global financial assets. Aggressive non-conventional monetary policies helped to push up market valuations.
We also monitor the performance of a Reference Portfolio which comprises 65% global equities and 35% global bonds.5 The Reference Portfolio is not a performance benchmark for the GIC Portfolio but rather, characterises the risk the Client is prepared for GIC to take in generating good long-term investment returns. On occasion, GIC may lower its risk exposure in times of market exuberance. Conversely, GIC may also increase its risk exposure when the opportunity arises. This is part of a disciplined, professional approach to long-term value investing.
Table 3 shows the nominal USD returns over 20 years, 10 years and 5 years and the corresponding volatility for the Reference Portfolio. The figures do not include adjustments for costs that would be incurred when investing.
|Time Period||Nominal Return6||Volatility7|
5 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’.
6 The Reference Portfolio’s rates of return are provided on a gross basis, i.e. without adjustment for costs and fees.
7 Volatility is computed using the standard deviation of the monthly returns of the Reference Portfolio over the specified time horizon.
Over the three time periods, the GIC Portfolio has lower volatility than the Reference Portfolio due to its diversified asset composition. In addition, increasingly stretched valuations in developed market equities have prompted a reduced allocation to this asset class in recent years. Nevertheless, despite its lower risk exposure than the Reference Portfolio, the GIC Portfolio has performed creditably over a 20-year period.
Managing the Volatile Path to Lower Long-Term Expected Returns
Looking ahead to the next couple of years, the investment environment remains challenging. In this backdrop of high valuations, slow global growth and significant uncertainties, we expect real returns for both the GIC Portfolio and the Reference Portfolio to be lower. The combination of low expected returns and high downside risks explains GIC’s continued cautious portfolio stance.
Market valuations remain elevated across a broad spectrum of risk-assets, including US equity markets and high yield credit within public markets. Valuation metrics for US equities, for example, continue to be well above historical averages.
Additionally, the business cycle in advanced economies, especially the US, is mature. Economic activity and corporate earnings may not grow for much longer before the business cycle turns. We expect growth in China to gradually slow due to ongoing efforts to contain leverage, a difficult balancing act between the quality and speed of growth. While global growth may hold up in the near term and will get a boost from the US fiscal stimulus, inflation is expected to pick up in advanced economies and lead to less accommodative monetary policy. This increases the possibility of a global economic downturn over the next couple of years.
A further escalation in trade protectionism and investment restrictions is another risk, with the US threatening to impose tariffs on key trading partners. Moreover, the uncertainties that we highlighted in previous years – tensions around income inequality, populism, geopolitical conflicts and the potential negative impact of disruptive technologies – still persist. In addition, declining credit quality, hidden liquidity risks, and a proliferation of investment strategies that rely on volatility and rates staying low have contributed to the underlying market vulnerabilities that could amplify any further sell-off.
Long-term returns are likely to be significantly lower than what we experienced since the 1980s given the high valuations today and the expected rise in interest rates from their current very low levels. Moreover, secular economic and earnings growth is expected to be more modest over the next 20 years than it has been since the 1980s due to structural headwinds from demographics, elevated debt, and lower productivity growth.
In this challenging investment environment, it is all the more important to maintain strong price discipline. This means not overpaying for assets, and reducing exposure when the risk-reward trade-off is less favourable over the long term. Our active strategy teams remain focused on utilising our long-term perspective, organizational capabilities and global network to identify attractive idiosyncratic opportunities. We believe this approach puts us in good stead to invest in this new environment.