GIC expects returns to fall further, will raise alternatives exposure

Even the most sophisticated and respected institutional investors are struggling to hit performance targets in the current environment.

Reporting a big drop in its average long-term return, Singaporean sovereign wealth fund GIC has outlined in its annual report why it believes global investors face much lower returns and plans to raise its allocation to alternative assets.

Five-year annualised performance fell from 6.5% in March 2015 to 3.7% in the latest year, as of March 31, though the fund did not reveal its performance specifically for that 12-month period. Over the next decade, GIC forecasts that its 10-year reference portfolio returns will drop to less than 2%, against a historical average of 5.2% since its inception in 1981.

Chief investment officer Lim Chow Kiat said in the report: “We expect a difficult investment environment with modest growth prospects, greater uncertainty and a high degree of volatility in the macro economy and markets. The long-term [20-year] returns in the coming years are likely to be significantly lower than what we saw since 1980.” (See figure 1 below.)

The fund also pointed to the fact that asset valuations were high and that low interest rates were likely to rise over time, removing support for high asset prices.

GIC’s analysis reflects the ‘lower for longer’ belief expressed by other asset owners, including Temesek. Indeed, a growing number of institutional investors – such as Abu Dhabi Investment Authority, China Investment Corporation, Malaysian pension fund Kwap and Australia’s Future Fund – have expressed similar concerns, as they have struggled to maintain historical levels of performance. Hence a widespread trend towards slashing performance targets.

GIC calculates its own performance numbers and, for an institution that is famously guarded about how much it manages, makes great efforts to explain its projections – though it is nowhere near as transparent as, say, Norway's state oil fund and, by its own admission, probably never will be.

Figure 1: Nominal returns of MSCI World index (global equities) since 1976

GIC’s asset allocation changed slightly in the current year, with global equity exposure dropping from 29% to 26%, emerging-market stocks rising from 18% to 19% and bonds and cash from 32% to 34%. The weightings in inflation-linked bonds, real estate and private equity remained at 5%, 7% and 9%, respectively.

The fund has the scope to increase its exposure to real estate to 13% and private equity to 15%. The executives indicated they would pursue a larger allocation as part of an ongoing diversification drive. It gave no indication of how much larger and over what period.

GIC adopted its reference portfolio in April 2013, which comprises 65% global equities and 35% global bonds. The fund operated a lower-risk-oriented portfolio during the early part of the last 20 years, which would have resulted in underperformance of the reference portfolio. However, the fund boosted its exposure to alternative assets such as real estate and private equity in the later period, bringing its long-term portfolio returns closer to those of the reference portfolio.

But there were other factors that contributed to the strong performance, such as a cut in public equity exposure (by more than 10 percentage points) from July 2007 to September 2008, “because of concerns that equities had become overvalued in the euphoric market environment of early 2007”.

This was a sound decision at the time but, as GIC noted, in the last five years developed-market stocks, especially in the US, have done particularly well. Hence the reduction in DM equity exposure meant it recorded lower returns than the reference portfolio over the past five years.

Long-term returns can vary substantially over time, even when averaged over 20 years, noted the report. GIC’s annualised 20-year rolling real return has varied widely around the 5.2% average generated between 1900 and 2015 (see figure 2 below). For example, the 20-year real return was below 2% for much of the first half of the 1980s, and was as high as 10% in 2000.

Figure 2: 20-year rolling real return of a US 65% equity/35% bond portfolio from 1900 to 2015