Monday, July 24, 2006

How good or bad is the GIC's performance? (hint: it's a trick question.)

The Government Investment Corporation of Singapore (GIC) is an investment management company established in 1981 to manage Singapore’s foreign reserves. According to its web site, GIC “strives to achieve good long-term returns on assets under our management, to preserve and enhance Singapore's reserves” by “invest[ing] internationally in equities, fixed income, foreign exchange, commodities, money markets, alternative investments, real estate and private equity.”

Although GIC is state-owned, it has never publicly disclosed details on the performance of its investments until recently. GIC announced that the average rate of return on its investments was 9.5% in U.S. dollars over the past 25 years. Following this disclosure there has been extensive debate in the Singapore blogosphere over whether such a return is good or bad. For one particular example see Mr Wang Bakes Good Karma: Sad Performance in which Mr. Wang describes GIC's performance as "dismal," "sad," and "shocking." Strong words for sure but can they be supported by facts?

What can be said about GIC's performance? Unfortunately, not much. To say a return of 9.5% is bad or good has no meaning since we do not know the riskiness of GIC's investments. This may seem surprising to those who envision Wall Street as chock full of investors who earn great returns based on their smarts and savvy. But the truth is that investors are constrained by the effects of what economists call the "efficient market hypothesis." In a nutshell, this hypothesis says if there is a large number of reasonable investors then the price of a stock reflects all available information. As a result no one can "beat the market" because the price is a good measure of the stock's value. That is, if a stock is priced at $5, then there isn't anyone lurking around who knows that the stock is really worth $10. To put it succinctly, there are no opportunities to make easy money, even for the shrewdest of investors, when there are many others searching for these same opportunities. Economists have a lot of faith in this particular hypothesis; it is supported in varying degrees by enough research papers to sink a battleship.*

As a result of the efficient market hypothesis we know that investors face a tradeoff between risk and returns: an investor can only expect to earn higher returns if he or she is willing to hold riskier stocks. To evaluate the performance of an investor, we ask whether an investor could have obtained higher returns while incurring the same amount of risk.

Against this backdrop, there is now something we can say about GIC's performance if we are willing to make a big leap of faith or two. Turning back to GIC's website, we see that the GIC lists prudence as one of its core values: "Prudence means being conscious that we have a broader fiduciary responsibility than most fund managers; that we are in the public eye and must therefore consider investment risks and reputational risks; that we exercise sound judgement and discretion." Let's intepret this statement to mean that GIC's objective is to avoid "too much" risk and be conservative. (Big leap of faith number 1.) Now that we have assumed the amount of risk GIC is willing to accept, we can measure its performance by comparing GIC's returns to an appropriate benchmark. That is, we can compare GIC's returns to the returns of stocks of similar riskiness, and, a singaporean economist cannot emphasize this enough, from the same time period, the past 25 years. Let's take the S&P 500 index and Dow Jones Industrial Average as our benchmarks. (Big leap of faith number 2.) Over the past 25 years, the average yearly return of the S&P 500 index is 9.3%. The Dow Jones Industrial Average average yearly return is 10.3%. So it seems that GIC's return of 9.5% is in the ballpark.

So why is asking whether GIC's performance is good or bad a trick question? It's a trick question because judging performance is more than looking at absolute returns. We need to know at the very least GIC's risk tolerance and its portfolio, which are not available, to make an objective evaluation.

* Alternative theories of market behavior have been developed but most economists continue to think in the framework of efficient markets.

13 Comments:

Anonymous porcorosso said...

I'm not an economist but I think there are a couple of things worth pointing out:

Any investment authority established by a government should not be measured against any fund manager hoping to outperform the market.

This is because these authorities have to fulfil wider policy objectives which could at times conflict with pure economic aims - for example, the highest returns could be had from collecting rents from buildings within the country but there may be good reasons why a government does not also want to be the largest landlord in the country.

Secondly, quantative measures may be less than meaningful given cost of capital, ROE and IRR as well as tax are all somewhat distorted given the position of these authorities.

Finally, most developed countries run a budget deficit so again any comparisons, even qualitative ones, would be limited to examples drawn from oil rich nations with a rather different political system and therefore different investment perspective.

7:00 PM  
Blogger Dragon Sea said...

Hi Economist.

ANother issue that you can consider (not from economics principles) is that of Performance Measurement.

Typically, when measuring performance measurements (usually for rewarding purposes), you would have to consider comparing over the following metrics

a) Time (performance this period versus previous period)
b) Budget (or hurdle rate, benchmarks)
c) Peer (or comparable competitors)

1:31 AM  
Blogger ILJ said...

References have been made to the efficient market hypothesis, blah blah. While it is all well and good theoretically, evidence in behavioral finance and elsewhere indicate prices aren't really that accurate as we would like them to believe.

An example is Post-Earnings Announcement Drift, where prices rise for an extended period after a positive/negative earnings surprise. This impact actually occurs over a period of weeks, months even, so evidently the market can't be all efficient if it takes so long for people to price in earnings.

While most funds on average underperform the market, it is due more to the cost structure than anything else. If the universe of funds make up the entire market, average return has to equal market return. After accounting for costs, you find that the "average" firm underperforms the market. This, more than anything else, justifies the common comparison of market to fund performance, because its saying if you are going to perform average, you're better off performing average cheaply, by buying an index fund.

We did have an indication of the risk profile, since they chose 40% bonds. Beyond that, I'm dim on the view that we should consider the risk profile of any other composition simply because anything else is a qualitative decision where to generate the best returns. If they want to expose themselves to real estate, commodities, etc, its their choice and they should be held accountable for that area's performance, be it good or bad.

1:50 AM  
Blogger a singapore economist said...

Porcorosso,
I agree that it is possible that the government objectives are different from a fund manager's. But we can still measure performance against a benchmark. If the government meets the benchmark while also satisfying other policy objectives, so much the better.


Dragon Sea,
I think we agree. BTW, your criteria are commonly discussed in a lot of finance research, which is a subfield of economics.


ilj,
Yes, there are exceptions to the efficient market hypothesis, as there are with any economic model, but the EMH has stood the test of time because of its robustness. And, to my knowledge, there is no one behavioral model that fares as well as the EMH, theoretically or empirically.

2:53 AM  
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6:43 PM  
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3:41 AM  
Anonymous Generic Viagra said...

we can't trust in the words of our government, each time that a politician say something this end in a total lie, specially when money we are talking.

2:03 AM  
Anonymous miami broadband said...

The GIC is, in general standars a good idea. Because when States have dead money (money with no purpose or use in more than 3 months) it is critical to do something good with it to improve goverment assets!

I strongly recomend to review the policies to improve utility

12:17 AM  
Anonymous metro ethernet said...

Is so interesting that If the universe of funds make up the entire market, average return has to equal market return. After accounting for expenses, you find that the is the minimum underperforms the market. This, more than anything else, justifies the common comparison of market to fund performance, because its saying if you are it would not be measured against any fund manager hoping to outperform the market.Very interesting views on it thanks you very much for the info.

3:12 AM  
Blogger Chu Jeang Tan said...

GIC is run more like a hybrid of hedge fund and private equity fund. Their strategy weightings and exposures can change significantly based on macro expectations and the opportunities available. I’d recommend judging their performance not with an index (long only equity) but based on absolute performance during crisis situations like 2008, and their abilities to capture profit opportunities exiting from 2008. For one, a 5 year return of 6.3% is already a positive sign, as most funds are still struggling to even keep above their high water marks. Another gauge of performance is their correlation to market on the down years. History has shown us that it is very, very hard to have low correlation, even for a hedge fund. So, don’t expect anything near zero or negative, even a 10-20% drop when the markets was down 40% is an adequate performance.

11:40 PM  
Anonymous pharmacy said...

You can't wrong to say that it was a bad performance.

3:45 AM  
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4:14 AM  
Anonymous Gabriel said...

Wow porcorosso, you made some really good points. Your reply was actually more insightful to me than the article (and probably most other articles dissecting GIC's returns).

Kudos

2:12 AM  

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