How Singapore’s S$266 Billion Invesment Giant Temasek Rode The Chinese Share Boom

IntheBlack, November 2015

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When the Singapore sovereign wealth fund Temasek unveiled an almighty 19.2% one-year return to shareholders in July, many questions followed. Aren’t sovereign funds supposed to be staid and boring, aiming for a shade over inflation? How much risk are they taking to come out with a number like that? And: how do we do the same?

Numbers like these – a total shareholder return of 16% a year since inception in 1974, 9% annualised over the deeply troubled last 10 years – cause many new sovereign vehicles to look to Temasek as a role model. “We want to benchmark ourselves against the best: Temasek, the Norwegians,” says Hassan Bouhadi, the chairman of the $67 billion Libyan Investment Authority. “That’s the sort of governance and professionalism we aspire to.”

But the truth is Temasek is quite unlike any other sovereign vehicle in the world. “The starting point,” says someone who has worked there, “is that we’re very different.”

If you look at almost any major sovereign wealth fund, you will find a balanced portfolio with a sophisticated mechanism of asset allocation. The biggest – like the Abu Dhabi Investment Authority (ADIA), Norway’s Government Pension Fund Global, or Singapore’s own Government of Singapore Investment Corporation (GIC) – disclose clear bands for the separation between debt, equity and real estate holdings, and in ADIA and GIC’s case, various alternative strategies. Kuwait, Korea, China; the picture’s always the same, with risk balanced out across the portfolio.

Temasek, though, is 100% equities – some of it pre-listing, granted, but still not a shred of stable and predictable fixed income. That’s the reason it can log a 19.2% one-year return, but it’s also the reason it could just as easily be a hefty loss, like the 30% drop it suffered in 2008-9. Temasek is a dramatically more volatile investment vehicle than most sovereign enterprises (compare for example ADIA’s steady 7.4% annualised 20-year return to the end of 2014, or Norway’s 6.12% over the last 10 years), and to understand why, we have to look at it in the context of Singapore’s overall financial matrix.

Leaving aside state pension vehicles like the CPF, there are three major sovereign institutions in Singapore: the Monetary Authority of Singapore (MAS), GIC and Temasek. The MAS is basically the central bank, and it invests in low-risk and stable treasuries; its purpose is the underpinning of the Singapore dollar. That is, by design, low-risk, low-return, and stable.

Then there’s GIC, which looks more like the classic sovereign wealth fund model: diversified across multiple asset classes, investing purely overseas, and managing the government’s official foreign exchange reserves. Its return model is to preserve the purchasing power of the Singapore dollar over the long term, or to put it another way, to beat inflation.

It’s because of the existence of those two institutions that there is room for something like Temasek. Temasek’s mandate is to earn a spread over its cost of capital over the long-term – a much higher hurdle than just beating inflation. To beat it, Temasek goes to equities, and accepts the volatility that comes with it because it invests for the very long term.

To understand Temasek properly, you also need to see where it came from, and it is to some extent the story of Singapore itself. “In the early years of Singapore’s independence, there was an acute priority to fill the employment and economic activity gap caused by the withdrawal of the Royal Navy, so the Singapore government established a number of companies that developed businesses in shipbuilding, offshore marine services and heavy industry,” says Stephen Forshaw, managing director of strategic and public affairs at Temasek in Singapore, and MD for Australia and New Zealand. By the early 1970s, “the government determined it should not be in the business of running commercial enterprises, but instead focus on its role as a policy-setter, regulator and steward of the economy.  So Temasek was formed, and the government’s shares in those operating companies were transferred to Temasek to own on a commercial basis.”

At first it was no more than a holding company with a few staff processing the ledger and banking the dividends. “In the early years, Temasek was fairly passive as an owner, but with the growth of these businesses came the opportunity to open the portfolio to investment,” Forshaw says. “As some of those companies were sold, merged into others or listed, the proceeds were used to begin a direct investment pipeline.” A key moment was the listing of SingTel in 1993, followed by other blue chips like Singapore Airlines and DBS Bank.

It’s only through an assessment of Singapore itself that we can realise how vital Temasek’s S$266 billion net portfolio value (as of March 31 2015) really is.

“Singapore is a small island nation,” says Forshaw. “It does not have the benefit of natural resources, agriculture or mineral or oil wealth.  It is a trading port, encouraging open and free trade of goods and services.  It therefore relies on the hard work and disciplined savings of its people, built up and inculcated since independence, to provide a solid position. Its fiscal prudence is something carried forward from the earliest days of self-government.” When you have nothing to dig out of the ground and no land to plant crops on, the discipline around national savings is exceptionally high.

Another thing that separates Temasek significantly from other sovereign vehicles is its dedication to emerging markets. Starting out as 100% Singaporean, it has steadily increased its outward expansion since 2002, and after the global financial crisis – when it was burned by exposure to western banks, particularly Merrill Lynch – it set upon a target geographical mix of 40:30:20:10, for Rest of Asia, Singapore, OECD countries and Other (chiefly Latin America) respectively. That means, all things being equal, that 70% of the portfolio will be in Asia at any one time; and that only 20% will be in western developed countries (including Australia).

No other sovereign fund looks like that. ADIA, for example, can go up to a ceiling of 20% in emerging market equities, and 25% of the whole portfolio in emerging market assets generally.

Temasek’s approach partly rests upon a conviction that they know what they’re good at: that the emerging world, Asia in particular, is what they understand. “As we stepped out into Asia and beyond to make direct investments, we have focused on investment themes, rather than sectors or geographies,” says Forshaw. “At their core, these themes highlight the growth opportunities in Asia and other transforming economies.  So even as we’ve opened offices in New York and London, our investment focus has remained companies which, while they may be in the US or Europe, are themselves benefiting from those transforming economies.

“They are catering to growth in China, India, Latin America and Africa, consistent with our thesis about investing in emerging champions that are catering to the growth of middle income populations, transforming economies and comparative advantages.”

Another distinctive point about the Temasek model is that it does almost everything itself. Its last annual report said that only 10% of the portfolio was run by external managers, and even that was a surprise: it’s hard to find a fund manager who’s won a mandate from them in the last 10 years. In fact, that mainly refers either to new markets where Temasek is still finding its way – Latin America is an example – or actually represents co-investment, where Temasek might partner with a venture capitalist in order to secure early access to promising investments in the future.

For a big institution, it’s also surprisingly nimble at timing the markets and shifting in and out of big positions quickly. The 2014-15 year was one of its most active on record: it divested S$19 billion of assets and invested S$30 billion. It prides itself on being able to act decisively, particularly in times of dislocation.

Which is just as well, for these are dislocated times, and one of the most fascinating questions about Temasek right now is just how badly it has been hit by the Chinese stock market crash.

In the last Temasek Review, showing the asset position on March 31, China accounted for 27% of the portfolio, up from 25% a year earlier and 23% a year before that. It holds almost as much in China as it does in Singapore. One holding alone, China Construction Bank, accounts for 6% of the portfolio. At the time of writing, China’s CSI300 benchmark had fallen 38.6% since June, which clearly must have hit Temasek’s portfolio.

“No matter how prudent they are, this will have hit them hard,” says one analyst in Hong Kong, who, in common with most analysts and fund managers, doesn’t want to be named in connection with Temasek (partly because of its power as an institution, partly because it has a track record of being litigious). “Having almost a third of your portfolio in China is risky. It has paid off for them over the last year, and now it’s hurting them instead.”

Indeed, any evaluation of the impact of this fall has to keep in mind the fact that Temasek also clearly took part in the climb in the first place. China’s A-share markets – the domestic ones – doubled in the space of a year. And a great deal of that climb happened after the March 31 reporting date of Temasek’s last review; so far, the market hasn’t fallen that much further than the level it already stood at back then.

Nevertheless, it’s reasonable to ask whether any institution that safeguards sovereign assets should be so exposed to such a volatile market, where price movements often have less to do with corporate fundamentals than the whims of heavily-leveraged retail investors. Privately, Temasek point out two things: one, that most of its investments aren’t in A-shares but in Hong Kong-listed H-shares (which is an unsatisfying response since H-shares have been hammered too, albeit they show greater stability); and two, that the bulk of its exposure is with the heavyweight Chinese banks like ICBC and Bank of China, which, while they might wobble with the market, are probably here to stay. It’s also possible that Temasek, given the agility it has shown in recent years, already sold down some of its holdings on the way up, and that also if it picks the bottom of this fall accurately it might do better still by deploying capital at an attractive entry point.

Temasek won’t comment on China specifically, but Forshaw says this. “We have built a resilient balance sheet over the years by investing in good, solid companies. We maintain a disciplined focus on the long term.  Our portfolio of mostly equities means higher year-to-year volatility for annual returns, including a risk of negative returns, but with an expectation of higher positive returns over the long term.”

In other words, it can ride out the bad times – but don’t be surprised if it has been opportunistic along the way. “We remain fully flexible in our ability to deploy capital, and we do not have predefined concentration limits or targets.”

BREAKOUT: Payback time

A small but significant change took place this year when Singapore’s government began incorporating Temasek’s expected returns into the national budget. MAS and GIC have always been in there; Temasek historically has not been, partly because it has been considered impossible to forecast returns from a volatile equity investor.

Temasek keeps its past reserves invested, but it has always declared a dividend. (That’s because Temasek, unlike GIC, is a private company, so a dividend is the mechanism through which the government can access Temasek’s returns.) The government then chooses whether to take that dividend, or to reinvest it within the portfolio, commonly the latter. The government has now come up with a new model to allow it to forecast the dividend that it will be offered, though under Singapore law it can only spend 50% of what it expects to receive.

This is relevant because there is a change underway in Singapore, perhaps related to the elections that were in progress at the time of writing, through which the government is trying to address social inequality and the need for a social safety net in a way it has not done before. Returns from Singapore’s various sovereign entities now account for about 15% of the national budget (S$8.6 billion last year) and are therefore instrumental in funding these newer social measures; that income almost exactly matched the S$8 billion Pioneer Generation Package announced in 2014, for example. It is likely that, as those social programmes grow, the government will more often than not choose to take the Temasek dividend rather than ask for it to be reinvested.

Ho Ching, Temasek’s CEO, has been taking to Facebook of late to explain this new responsibility. “For the teams in GIC, MAS and Temasek, and perhaps for Team Singapore as a whole too, the load on the shoulders may seem a bit heavier to ensure that we continue to deliver for the long term, with discipline and integrity,” she says.

This helps address the question of what Temasek is actually for.  We know what ADIA or the Norwegian fund are for: when the oil runs out, so there’s something left when it does. We know what GIC, China’s CIC or Korea’s KIC are for: diversifying foreign exchange reserves. So what’s Temasek? For a rainy day? The use of the dividend for social improvement gives us a partial answer. As Ho says: “It gives meaning to those of us working in these institutions, past and present as well as future.” It’s good to have a purpose.

BREAKOUT: Timeline

1965: Singapore becomes an independent nation. It owns many local companies.

1974: Temasek is incorporated under the Singapore Companies Act to hold and manage the assets owned by the Singapore government and run them on a commercial basis. It owns 35 companies worth S$354 million at the time.

1993: Listing of Singapore Telecommunications generates cash in the portfolio and changes Temasek’s nature, making it an active investor. Other major Singaporean holdings that are subsequently listed and generate cash for Temasek include DBS Bank, Singapore Airlines, Neptune Orient Lines, Keppel and SembCorp Marine.

2002: Launches Temasek Charter spelling out its values and direction. Steps up investment in Asia.

2003: Purchase of 51% of Bank Danamon in Indonesia illustrates increasing Asia focus. SARS epidemic hits markets. Sets up Fullerton Fund Management subsidiary.

2004: First investments in Russia (Mobile Telesystems), Malaysia (Telekom Malaysia), and in airports (Airport Authority of Thailand); takes 19% stake in Jetstar Aiways. Inaugural rating: AAA

2005: Investments include China Minsheng, China’s first privately owned bank; India’s Mahindra & Mahindra; China Construction Bank; and Bank of China.

2006: Takes stake in Thailand’s Shin Corp, which will prove to be the most controversial and politically charged investment in its history. Buys 11.5% of Standard Chartered.

2007: Sets up its own infrastructure investment vehicle, CitySpring Infrastructure Trust.

2009: Annual results show 30% year-on-year loss of total shareholder value through financial crisis. In the early months of the year it sells out of Barclays and Bank of America Corp at the bottom of the market. Though much ridiculed at the time, the money is reinvested elsewhere, such as Olam International, and may have made more from doing so than it would have done by holding onto the western banks.

Launches new Temasek Charter and pledges increasing focus on Asia and emerging markets.

2010: Sets up Seatown Holdings investment subsidiary.

2015: Reports 19.2% year-on-year total shareholder return. Portfolio is worth S$266 billion.