How Singapore’s S$266 billion investment giant Temasek rode the Chinese share boom

Singapore's iconic Merlion stands majestically against the city's soaring backdrop

Unorthodox, resilient and with an enviable earnings record, sovereign wealth fund Temasek is not frightened by the equities roller-coaster.

When the Singapore sovereign wealth fund Temasek unveiled an almighty 19.2 per cent one-year return to shareholders in July this year, 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? How do we do the same?

Numbers like these – a total shareholder return of 16 per cent a year since inception in 1974 and 9 per cent annualised over the deeply troubled past 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, chairman of the US$67 billion Libyan Investment Authority.

“That’s the sort of governance and professionalism we aspire to.”

“Having almost a third of your portfolio in China is risky. It has paid off for them … now it’s hurting them instead.” Hong Kong analyst

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 – such as 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 balanced out across the portfolio.

A key moment in Temasek's expanding investment strategy was the listing of blue chips such as Singapore Airlines, DBS Bank and SMRT Corporation

A key moment in Temasek's expanding investment strategy was the listing of blue chips such as Singapore Airlines, DBS Bank and SMRT Corporation

Temasek, though, is 100 per cent 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 per cent one-year return, but it’s also the reason it could just as easily be a hefty loss, like the 30 per cent drop it suffered in 2008-09. Temasek is a dramatically more volatile investment vehicle than most sovereign enterprises – compare, for example, ADIA’s steady 7.4 per cent annualised 20-year return to the end of 2014 or Norway’s 6.12 per cent over the past 10 years. 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 Central Provident Fund (CPF), there are three major sovereign institutions in Singapore: the Monetary Authority of Singapore (MAS), GIC and Temasek.

MAS is basically the central bank, and it invests in low-risk and stable treasuries. Its purpose is the underpinning of the Singapore dollar – which 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.

From passive beginnings

To understand Temasek properly, you also need to see where it came from, and that is to some extent the story of Singapore itself.

Stephen Forshaw, managing director of strategic and public affairs at Temasek in Singapore and MD for Australia and New Zealand, explains: “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.”

By the early 1970s, says Forshaw, “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 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,” says Forshaw.

“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 Singapore Telecommunications – Singtel – in 1993, followed by other blue chips such as 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 31 March 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.”

Unconventional fund

Another thing that separates Temasek significantly from other sovereign vehicles is its dedication to emerging markets. Starting out as 100 per cent 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 per cent of the portfolio will be in Asia at any one time and that only 20 per cent 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 per cent in emerging market equities and 25 per cent of the whole portfolio in emerging market assets generally.

Temasek CEO Ho Ching

Temasek CEO Ho Ching

Temasek’s approach partly rests upon a conviction that it knows what it’s good at; that the emerging world, Asia in particular, is what it understands. 

“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 with companies that, 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.”

There’s one more distinctive point about the Temasek model: it does almost everything itself. Its last annual report said that only 10 per cent of the portfolio was run by external managers, and even that was a surprise, because it’s hard to find a fund manager who has won a mandate from Temasek in the past 10 years.

In fact, that mainly either refers to new markets – 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, Temasek is also surprisingly nimble at timing the markets and shifting into 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.

Chinese volatility

In the last Temasek Review, showing the company’s asset position as at 31 March 2015, China accounted for 27 per cent of the portfolio, up from 25 per cent a year earlier and 23 per cent a year before that. Temasek holds almost as much in China as it does in Singapore. One holding alone, China Construction Bank, accounts for 6 per cent of the portfolio. At the time of writing, China’s CSI300 benchmark had fallen 38.6 per cent 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.

“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.”

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 31 March reporting date of Temasek’s last review. 

So far, the market hasn’t fallen that much further than the level it had already reached back then. Nevertheless, it’s reasonable to ask whether any institution that safeguards sovereign assets should be so exposed to such a volatile market.

Privately, Temasek points out two things: one, that most of its investments aren’t in A-shares but in hammered too, albeit they show greater stability); and two, that the bulk of its exposure is with the heavyweight Chinese banks like the Industrial and Commercial Bank of China (ICBC) and Bank of China, which, while they might wobble with the market, are probably here to stay.

“We have built a resilient balance sheet over the years by investing in good, solid companies.” Stephen Forshaw, Temasek

It’s also possible that, given the agility Temasek has shown in recent years, it had already sold down some of its holdings on the way up. Further, 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, Temasek 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,” adds Forshaw, “and we do not have predefined concentration limits or targets.” 

Payback time

A small but significant change took place this year when the Singapore Government began incorporating Temasek’s expected returns into the national budget. MAS and GIC have always been in there; Temasek historically has not, 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 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 per cent of what it expects to receive.

This is relevant, because a change is underway in Singapore, with the government 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 per cent 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 programs 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: to ensure there’s something left when the oil runs out. We know what GIC, the China Investment Corporation (CIC) or the Korea Investment Corporation (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.

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November 2015
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