GIC’s view of investing in a world of disruptions

THE global investment environment continued to change in fundamental ways over the last year. The Russian invasion of Ukraine has persisted, inflicting growing human and economic tolls. Together with highly expansionary macroeconomic policies in the major economies, the war also contributed to the jump in global inflation rates, ending a 40-year disinflationary trend.

To rein in inflation, major central banks embarked on aggressive interest-rate hikes. In the US, the energy transition saw a major boost following the passage of the Inflation Reduction Act.

Since late 2022, generative artificial intelligence (AI) has caught on at an unprecedented speed and scale, with its wide-ranging but uncertain impact creating optimism or pessimism, depending on where you sit. In China, the surprise decision to end its strict Covid policy raised hopes for better global growth this year.

For investors, 2022 was also a watershed year, where global bonds fell by 16 per cent and equities by 18 per cent in US dollar terms, posing a challenge to portfolios which were relying on bonds to offset equity risk.

The valuations of businesses with distant future cash flows were hit particularly hard. At the same time, financing conditions in capital markets tightened significantly, resulting in a steep drop in investment deal volume.

We are not out of the woods yet. The consequences of the policy tightening are still being felt in the economy and markets. Some banks face the prospect of low profitability due to higher funding costs and potential loan losses. Housing markets relying on floating rate mortgages are also experiencing refinancing pressures.

At the same time, de-globalisation pressures continue to build up, fuelled by intensifying great power rivalries. In addition, climate risk continues to rise, manifesting in more natural climate disasters.

Despite these challenges, GIC’s long-term performance has remained resilient. As at Mar 31, 2023, for the 20-year period from Apr 1, 2003, the annualised US dollar nominal return of our portfolio was 6.9 per cent. Adjusting for global inflation, the annualised 20-year real return stood at 4.6 per cent, a slight increase from last year’s 4.2 per cent.

An era of continued uncertainty

The disruptions associated with persistent inflation and chronic geopolitical risks remain relevant today. In addition, there are two new disruptions to grapple with.

The first is a potential structural shift to a regime of higher interest rates. With last year’s quick succession of interest-rate hikes and persistent inflation, we are likely to see interest rates being “higher for longer”. Absent another major shock to financial markets or economic growth, we have likely left behind us the world of zero interest rates.

While the resulting higher prices of capital will benefit long-term investors, the transition to a higher interest rates world will be difficult for many businesses and even countries. Those with business models reliant on very low interest rates will need to make significant, and sometimes painful, adjustments. Even their viability may be in doubt.

The second is the impact of generative AI. While AI has been around for years, the recent advent of generative AI, including large language models, raises great promise as well as hazards. Many real-world use cases are appearing, and multiple variants of open-source AI models are being released at a rapid pace.

Financial markets are digesting the news, with more assets being repriced. While technology companies are the current focus, all businesses will soon need to adapt. AI has the potential for creative destruction and could also deliver productivity improvements that help keep inflation in check.

It also naturally brings with it worries of threats to cybersecurity and societal norms. Naturally, governments are taking a deep interest in this development.

Investing through disruptions

To navigate these disruptions, GIC is guided by our core investment principles of taking a long view, diversifying our exposures and, importantly, preparing instead of predicting. In this era of continued uncertainty, making our portfolio more resilient is a key focus. We will continue to seek out investment opportunities with stable long-term returns.

This era of high uncertainty started several years ago. In particular, investors have been concerned with the prospects of poor average returns and a wide range of likely returns even over the long term.

Consequently, GIC embarked on an effort to strengthen our portfolio resilience. We began to integrate market (beta) with active (alpha) returns, and to take a more granular approach in adjusting our exposures.

A specific portfolio action was to raise the liquidity of our portfolio. While valuations have corrected to some degree in the past year, we remain cautious. We have also been emphasising stable income-generating assets that protect our portfolio against inflation. Finally, in response to shifts in supply chains, we have incrementally moved our capital to sectors and countries benefiting from these shifts.

GIC has been building up our infrastructure assets as part of a long-term effort towards resilient returns.

We have also made further progress in integrating sustainability into our investment and corporate processes. Last year, we established a central sustainability office to raise our research and policy capabilities, and to support our investment teams in their decarbonisation trajectories. As a long-term investor, we see promising opportunities in the green transition, which we are seizing through focused teams across asset classes.

In the public equities department, we set up the climate change opportunities portfolio to deploy more capital towards climate mitigation and adaptation. In the private equity department, we created the sustainability solutions group to invest in early-stage energy transition opportunities. And in the fixed income and multi asset department, a new transition and sustainable finance group was formed.

A world of disruptions holds many challenges but also opportunities for investors. GIC will continue to prepare for them, and stay anchored in our mandate, values, and investment principles. Most importantly, we will stay committed to our purpose of safeguarding Singapore’s financial future.

The writer is chief executive officer of GIC. This is an abridged version of The Letter from the CEO in the FY2022/2023 GIC Report