On Tharman's comments about Temasek, and more

On Tharman's comments about Temasek, and more

Singapore's Minister of Finance, Mr. Tharman Shanmugaratnam, has spoken in Singapore's parliament about Temasek's performance to date. The Straits Times reported the news with an article titled "Temasek beats returns of many big funds" and stating that there has been a gain of S$114 billion in the five years before the fall, and a gain of S$56 billion after losses. They also reported in the article that Temasek thus averaged slightly over 15% annually over the five year period. That just sounds heartwarming, doesn't it?

But a look at other news sources, namely from the Asian Wall Street Journal and Bloomberg news show that Temasek had gained S$114 billion over five years (from 2003 to 2008), and proceeded to lose half, no, more than half of that sum (S$58 bilion) in a mere eight months (from March 2008 to November 2008).

The Asian Wall Street Journal has a graphical representation that pretty much says it all.

On reading all these articles, there are two contentious points about Mr. Tharman's defense of Temasek: firstly about Temasek's performance vis-a-vis benchmarks, and secondly about the assertion that it is not realistic for Temasek to avoid losses amid sharp market corrections.

Temasek's performance: one eyed man in the land of the blind, or the Toyota behind the Ferraris?

Tharman defended Temasek's performance, stating that Temasek has performed "respectably" compared to relevant market indexes and reputable institutional investors. The article quotes Tharman as saying

"Temasek has achieved total shareholder returns of ..... slightly over 15% per year on average over the cycle. This compares with 6% annualised gain in the global equity market indices (MSCI World)... Temasek's annualised returns are also higher than what several other well-regarded investors have earned over the cycle."

A question for Minister: which "well-regarded investors" have Temasek beaten, and how did the whole population of these "well-regarded investors" do as a whole? For instance, if Temasek is comparing itself with its sovereign-wealth fund peers, then Temasek's performance is excellent in the same way that a Toyota Camry will hugely outperform an East German Trabant on a racetrack. Soveregn wealth funds on the whole have been performing badly, based on a few abstracts on academic studies that I was able to find via Google: a working draft here, and here. This paper's abstract states that the sovereign wealth funds they studied showed an average annual return of -14% over two years, whereas Temasek's returns over a two year period is probably slightly positive. By using this benchmark, Temasek is the one-eyed man in the land of blind investors, and has truly done well.

But the same Toyota Camry mentioned above will be sorely lacking if it was benchmarked against a Ferrari on the same racetrack. You might ask, "which institutional investor can be considered an investing Ferrari?" As I'd written before, the Yale Endowment fund has been hugely successful over this same period of time that Temasek has mentioned, and their portfolio's returns are a lot less volatile. Just compare the respective portfolio values in the following two pictures:

Temasek's portfolio value until 2008

Yale endowment's portfolio market value until 2008

Both are linearly scaled on the vertical axis, and are thus comparable by eyeball. Look closely at Temasek's portfolio, and notice how there was a HUGE 40% drawdown from 2000 to 2003; in contrast, Yale's fund went from around US$11-12 bn to $10bn, which represents a mere 10-20% decline, while their bounce up has been just as spectacular (they more than doubled from 2003 to 2008). Graphically you can see that Yale's returns are much better adjusted for risk.

We should also bear in mind that Temasek had the benefit of privatizing government-linked corporations, which were basically state monopolies: much of the gains in their portfolio's market value stemmed from all these one-off initial public offerings, as can be seen from the notation on Temasek's chart. In contrast, Yale's performance stems from pure investment returns, diversified over different asset classes which even out its returns.

From this perspective, Temasek's returns might not be that fantastic, especially relative to the risks involved.

The question then begs to be asked: are we comparing Temasek with the blind, or with the best-in-class Ferraris?

Temasek's portfolio: diversify or die

Minister also said in the article that it was not realistic for Temasek to outperform the market everytime or to avoid losses amid sharp market corrections.

I think any sane person will not expect Temasek to outperform the market everytime: if even the God of All Investors (i.e. Warren Buffett) occasionally lags the Dow (especially just before 2000), it is extremely unrealistic to expect Temasek to outperform the market all the time.

But what we can and should expect is for Temasek to reduce its losses during sharp market corrections like now, even as they seek higher returns. As I said before here, Temasek's portfolio is extremely concentrated in terms of asset class and geography.

A friend critiqued my argument by stating that given Temasek's size, it is not exactly fair to compare Temasek with Yale's endowment fund, which is a fifth of Temasek's size. But I think he misses the main point: if a smaller fund like Yale's can diversify across 6-7 different asset classes while pursuing high returns like Temasek's mandate, does it make sense for a fund of Temasek's size to remain as concentrated as it is in a single asset class in its pursuit of returns?

For naysayers about Temasek's ability to diversify, bear in mind that Temasek's sister firm, the Government Investment Corporation of Singapore, or GIC is actually quite spread out across different asset classes, including Treasuries, currencies, and fixed income (see page 11 of GIC's annual report here). GIC's mandate is quite different from Temasek's: their aim is basically to just beat global inflation, which explains why their returns are much lower, and their diversification into alternative assets is too small to make much difference to the portfolio on the whole (e.g. Emerging Market equities are just 10%, Absolute Return strategies make up just 3% of the portfolio, Natural Resources a mere 2%, and Private Equity just 8%). Should Temasek adopt a similar policy of asset diversification, these alternative asset classes should probably take up a larger portion of Temasek's portfolio in pursuit of higher returns.

GIC's broad diversification across different asset classes shows that a large sovereign wealth fund like Temasek can diversify into different asset classes. It really makes me wonder why Temasek is sticking only to equities: in a pursuit for returns, it almost seems reckless not to diversify especially when you are a giant, especially since it will boost your risk adjusted returns and reduce the chance of being aversely affected by Black Swan events. It is not for nothing that Harry Markowitz called diversification "the only free lunch", one which Temasek is basically not having by being hugely concentrated in equities (especially in financial institutions).

A question of corporate governance?

While researching for this blog post, I was looking through GIC's annual report for 2007-2008, and what struck me was the composition of GIC's board of directors and their advisors: it is fairly obvious that GIC is aggressively tapping into some very sharp financial minds, as their board advisers include a number of heads of investment fund and investment advisory firms. One of them is even chairman of Goldman Sachs' Quantitative Investment Strategies Group.

In contrast, Temasek's board mostly consists of ex-CEOs, who often don't have the necessary appreciation of finance or financial risk. Last time I counted, I counted two chaps with relevant financial/investment expertise on Temasek's board: one was a lawyer who also works in an investment firm, while the other is a member of the Swedish Wallenberg family.

This difference might account for the different asset allocation strategies by the two firms. While Temasek has done well, in my personal opinion there is definitely scope for more improvement. Perhaps it is time for Mr. Tharman and the Minstry of Finance to look more closely at Temasek's board composition, and to model it more after GIC by injecting more experienced financiers, or at least to create a board of advisors to Temasek's Board. Afterall, financial investing is a very different ball game from buying over a company as a CEO.

(Incidentally, Minister is also on GIC's Board. One can only hope he has been tapping GIC's board advisors on the matter of Temasek's investments...)

Time to look more closely at Temasek's risks

In summary, I basically disagree with Mr. Tharman about his statements on Temasek, and think that Temasek ought to implement certain changes. More clarity is needed on the type of benchmarking that is used to gauge Temasek's performance, and I think a closer look needs to be taken on the risks that Temasek is taking on.

Given the Singapore government's general risk aversion (we have one of Southeast Asia's strongest militaries, despite being one of the smallest nations in the region) and preparations for foreseeable risks and contingencies, I find it puzzling that the approach towards Temasek's portfolio risk seems to be verging on indifference. There is a saying amongst traders that "if you look after the risk, the returns will take care of themselves".

If we persist with the current attitude towards Temasek's portfolio concentration and other risks, then it won't be long before the S$56 billion portfolio gain evaporates into nothingness. Solon's warning still rings true. I think it is high time for us to look closely at Temasek's strategy, and to take steps like diversification to reduce the risks to Singapore, and changing their board composition

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