17 Jul Temasek Review 2015 – Lessons for a Retail Investor
Temasek Holdings published their annual report last week. With a Net Portfolio Value of S$266 billion, Singapore’s Sovereign Wealth Fund manages global assets on behalf of the Singapore Government.
As a fund manager running billions, they operate on a different level and face a different set of issues from the retail investor.
The retail investor would bemoan insufficient capital to build their ideal portfolio while Temasek worries about how to deploy that considerable capital at their disposal efficiently. The retail investor is concerned about minimum transaction charges eating into their margins while a bemoth like Temasek would be cautious about their investments moving markets.
Despite all these differences, I believe that the principles of investing remain very much similar. A retail investor would have lots to learn about how Temasek does business. Here are some of my takeaways after reading the report.
Our capital structure allows us to take a view on long term trends, and weather the cycles of short term volatility
Short term returns are granular and volatile, while longer term returns tend to be more stable. Throughout the report, Temasek tends to project returns based on 20 year cycles and many of their charts and numbers reflect this outlook.
In the entire report, the phase ‘long term’ appeared 31 times. That speaks a lot for their investment time frame. And that is very much in line with the philosophy of Singapore’s other Soveriegn Wealth vehicle, the Government of Singapore Investment Corporation. Alvin wrote about it here.
We cannot stress enough the importance of time in the market and letting the effects of compounding work its magic on our money. As human beings we tend to be impatient and we require instant gratification. We want our stocks to double tomorrow and double again the day after.
Unfortunately that is not how the investing game is played. The game is not played over days or weeks or even months. The investment battlefield stretches into years.
As Warren Buffett famously quotes –
No matter how great the talents or efforts, some things just take time. You cannot produce a baby in one month by getting nine woman pregnant.
Investing takes time to produce results. Temasek understands this, so should every retail investor.
Take care of the Downside and the Upside will take care of itself.
Using their proprietary Temasek Geometric Expected Return Model, (T-GEM) to simulate the range of possible outcomes for their portfolio, Temasek is able to project portfolio returns based on different economic scenarios.
Starting with the characteristics of our Temasek portfolio, we use T-GEM to simulate our likely returns for the medium to long term, under various economic scenarios. As of March 2015, we have five economic scenarios described in the table below.
Clearly listed out, Temasek believes that three global development could have a significant enough impact on their portfolio value. They are the Euro Zone Deflation, the US Monetary Shock and the China Credit Stress.
Based on our views of the economic outlook, we develop a series of scenarios each year, adding new ones as new risks appear and dropping old ones which are no longer relevant.
Using their model, they have worked out the compounded annualised returns over a 20 year period given any of these scenarios. In the case of the China Credit Stress Scenario, the model has predicted that Temasek’s expected returns will be reduced by almost 2% compounded.
The retail investor has no access to such complex models. Neither is it neccessary. It is not the projections that is important. It is how Temasek approaches risk that struck me the most.
Fixation with returns
The retail investor tends to be fixated with returns. REITS and dividend stocks are preferred for passive income. We like to buy growth stocks at their IPO because they display huge potential. That overseas investment property with guaranteed 12% returns for the first 3 years. It is the potential returns that lock us in.
How many of us actually weigh that returns with risk? How many of us take risk into consideration when we invest? How many of us even know the risk level of our investments? Have we ever considered the worst case scenario like Temasek does?
As a steward of Singapore’s money, it is prudent and sound for Temasek to do so. As an investor of our own money, all the more we should too!
Our Total Shareholder Returns (TSR) is measured against our risk-adjusted hurdle rate, which is derived using the capital asset pricing model.
During the Value Investing Mastery Course we conduct, there is a section devoted to measuring and tracking investment returns. We would always ask the class participants how many actually track their portfolio returns. We would be lucky to get more than a handful in each class.
Tracking returns is crucial for a few reasons. Firstly, what gets measured gets improved on. The runner looking to better his time must first know what his personal best timing is.
The serious investor looking to improve on his or her investment outcome must also know what entails an improvement. If he does not know how well he did the year before, he will never know for sure if he has improved on his performance this year, or the year after.
Secondly, tracking and measuring also allows an investor to benchmark results against other returns. Temasek uses the risk adjusted hurdle rate. The retail investor would do well to use a risk-free rate or the effort free rate.
If the bank pays you 1% on your deposits for example, you need to return better than 1% consistently on your investments. This is to compensate you for taking on additional risk. Failing which, you are better off leaving the money in fixed deposits.
If buying and holding the STI ETF leads to a 9% return over the long run, an investor picking stocks must beat 9% constantly. Otherwise the addition efforts he put in to select stocks would have gone down the drain. He would be better off passively investing in an index fund and spending his time with family or pursuing other leisure activities. In the same vein, if Temasek is not able to beat the risk-adjusted hurdle rate consistently, they really should not be in this business.
All Eggs in one Basket?
With the amount of capital at their disposal, it is inevitable that Temasek needs to diversify. They account for their diversification from all aspects.
As a global portfolio manager, Temasek owns assets across different continents. Beyond geographical diversification, they also segregate their assets according to sectors, liquidity and currency exposure.
Beyond investing in listed and stable businesses, Temasek also looks to invest for growth. This is executed via their Enterprise Development Group.
Temasek plays an enabler role across all stages of an enterprise, from early stage investments to disruptive business models. Our direct investing activities are complemented by the Private Equity Fund Investment team,
With the EDG, money is channeled into start ups and SMEs with great growth potential. With their investment vehicles Heliconia Capital and Vertex Venture, Temasek functions as a private equity investor and venture capitalist. This allows them to invest in companies at all stages of the business cycle.
Basic Investing Principles
The Temasek Review 2015 gives us a good picture of how the organisation functions. The underlying structure and processes behind Temasek is complex but the basic principles of investing remains unchanged.
Investors could do well to adopt a long enough time frame, understand the risk behind their investments, track returns religiously and also ensure that they are adequately diversified.