Interview with Dr Christopher Balding on Singapore’s SWFs

New Asia Republic

Temasek Holdings Press Conference. Left to Right: Simon Israel, Ho Ching, Leong Wai Leng

Dr Christopher Balding is currently an Assistant Professor at the HSBC Business School, Peking University. He earned his Bachelor’s degree in International Affairs and Masters in International Economics respectively at The George Washington University, and subsequently obtained his PhD in Political Economics from the University of California. Earlier this year, he published a working paper entitled “A Brief Research Note on Temasek Holdings and Singapore: Mr. Madoff Goes to Singapore”. His research interests lie in the area of International and Political economics. He currently blogs at www.baldingsworld.com.

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Balding: From a financial perspective I see nothing wrong with sovereign wealth funds investing in their home markets. From a political stand point, it is very difficult to do so without creating extreme conflicts of interest. Let me give you a little background before answering your question.

First, most SWFs do not have capital markets that can be considered investment destinations so for many especially newer funds, this is not a problem.

Second, some SWFs have explicitly forbid domestic investment or tried to separate those functions. For instance, the China Investment Corporation (CIC) outside of its domestic holding arm which holds primarily their stake in the 4 major state banks forbids domestic investment. It should be noted however, that the CIC has purchased China focused ETF’s on US financial markets, subverting the intention of preventing domestic investment.

Third, I believe it is reasonable on many levels that SWFs would want to invest domestically. The biggest problem is the potential for political influence or conflicts of interest. If we consider Singapore, Temasek is surrounded by conflicts of interest and politically influenced investments beginning with its senior leadership all the way to its portfolio companies. Only in Singapore would the head of the sovereign wealth fund being married to the prime minister not be considered a family run operation.

The type of behavior occurs regularly in Middle Eastern SWF but it is recognized for what it is: control by the ruling family. SWF that want to invest in domestic market may want to consider allowing external fund managers to invest their funds domestically to avoid conflicts of interest. I have much less concern about international investment for most any SWF because of a variety of difficulties. For instance, Temasek is not going to be able to seriously influence Chinese government policy on their 4 major state banks.

Balding: I actually believe that SWF should be able to invest at home but I also just as strongly believe that it can allow for major problems and real distortions if politics is not separated from profit.

The primary problem is that investing at home without necessary safeguards can create very real conflicts of interest and politicization of investment. In fact, many sovereign wealth funds actually take steps to address this problem. The China Investment Corporation has a prohibition on domestic investment.

Other sovereign wealth funds, allow investment domestically only under narrow circumstances like through external asset managers. Only in Singapore is the head of a SWF being married to the prime minister not considered a conflict of interest or a family appointment.

In many Gulf sovereign wealth funds, the ruling family maintains control over the SWF, but everyone admits it is family controlled. Only in Singapore is a family member running a SWF not a family member or a conflict of interest. Furthermore, it creates very real conflicts of interest. One minister who was also the manager of a portfolio company of Temasek in an interview actually said that sometimes “I write letters to myself”. This has the clear impact of creating an unlevel playing field for firms. There is not restraint on regulation and favored investment.

Editor’s Note: In order to alleviate concerns of corporate governance at Temasek Holdings, New Asia Republic understands that Prime Minister Lee Hsien Loong’s wife Madam Ho Ching, as Executive Director, does not report directly to the Ministry of Finance. Instead, she is accountable to the Executive Committee which is answerable to the Board of Directors which in turn reports to the Ministry of Finance.

Balding: As has been pointed out, Singapore’s debt is somewhat atypical compared to other governments but just as importantly, that does not make the debt any less important or any less real. Singapore created bodies like the Central Provident Fund that mandated contributions by citizens where the government could easily borrow funds. This has a couple of major impacts.

First, the government of Singapore essentially passed a law requiring it citizens to lend it money. I know of no other country where citizens are by law required to lend its government money.

Second, the government of Singapore only profits when it earns money in excess of the guaranteed rate of return owed to its citizens. Otherwise, the government and taxpayers are subsidizing investment losses of Temasek and GIC. In recent history, there is little evidence that supports the idea that Singapore is earning a profitable rate of return able to guarantee the debt owed to bodies like the CPF. Net asset growth after accounting for increases in debt have hardly increased implying that Singapore is failing to earn a profitable rate of return that it needs to guarantee CPF holders.

Third, Singaporean sovereign wealth funds like Temasek and GIC are bearing essentially no risk. Singaporean tax payers bear the risk of GIC/Temasek but do not share the benefits. If GIC and Temasek fare poorly or collapse, the Singaporean tax payer will have to bear the cost of guaranteeing the CPF. However, if GIC and Temasek do a good job the CPF debt holder earns 2.5-4%, then GIC enjoy the entire difference. This is a profoundly perverted structure where the people providing all capital and bear all the risk and enjoy none of the rewards.

While Singapore instituted sound policy of requiring individuals to save for retirement, rather than allowing the government to borrow money from the CPF at low investment rates, there are many better alternatives. Let me give you two examples.

First, Chile instituted a similar system where individuals payed into their account but the government opened up the investment system to external asset managers. Studies show that Chilean savers have fared quite well compared to other social security systems where savers earn a below market rate of return.

Second, rather than forcing Singaporean savers to lend at a such a low rate but capturing the market gains for the state, make CPF account holders “equity” holders that receive a dividends about their investment. The state of Singapore through GIC/Temasek is a defacto asset manager for the Singaporean people who lend them the money either through debt or budget surpluses.

It would be better financially for the Singaporean people, who guarantee their own debt anyway, to have a stake in the performance of the SWF’s.

Balding: As Singaporean debt is slightly different than other countries, it has some unique implications. Let me begin by saying that just because the debt has some different characteristics, does not make it any less real, less important, or less necessary to bring down.

First, the Singaporean government is extracting public savings from its people in the form of enormous current account and government surpluses. By running such large and sustained government surpluses, the government is extracting savings from its own population.

Second, by failing to run a balanced budget the government is failing to provide public services for its citizens. As has been demonstrated time and time again, though Singapore claims it is a low tax haven, many services which are government provided in other countries are paid for via fees in Singapore.

Third, the government is capturing the financial reward of the risk taken by the people of Singapore. Let me give you an example. If a CPF holder invests $1,000 and GIC/Temasek can pay back the 2.5-4% debt Singapore incurs to borrow money from the CPF, the government captures the difference between 4% and 10% (for instance) even though it is the peoples money.

However, if GIC/Temasek cannot pay back the debt, the government will go raise taxes on the CPF holder who invested his $1,000 asking him to subsidize the losses incurred by Temasek/GIC. If the people of Singapore are being asked to take the financial risk, they should enjoy the financial rewards. Fourth, Singapore is taking enormous financial risk.

At a roughly 2:1 leverage ratio, Singapore is running significant risk. For instance, during the financial crises when Temasek incurred a 31% drop, there were probably days during this period when Singapore had more debt than assets. This seems like an unacceptably high level of risk to be running with national finances.

Balding: In the foreseeable future, no. There is a very simple reason for that.

Singaporean citizens are obligated by law to pay into CPF and the government of Singapore will borrow from the CPF and other sources. The government could easily reverse this trend by making CPF holders equity stake holders in GIC/Temasek rather than continuing to borrow but this would necessitate allowing Singaporean citizens greater voice in increase accountability which I see no evidence of the government changing.

Balding: There is no evidence that most companies under the Temasek umbrella are top companies that are globally competitive. The most efficient companies expand overseas increasing their revenue, profitability, and returns. With a couple of exceptions, most companies under the Temasek umbrella remain dependent on the Singaporean market unable to significantly expand abroad.

For sure there are a couple of examples, but most Temasek portfolio companies remain dependent on their home market unable to capture significant growth abroad. This indicates that Temasek companies are not the globally competitive, efficient profit machines they are portrayed as. There are many examples of failed foreign investments by Singaporean state linked entities under the Temasek umbrella.

The most efficient companies expand internationally and increase profits and we do not generally see this with Temasek linked companies. In fact, earnings per share in most public Temasek portfolio companies is relatively flat over the past decade.

Balding: Temasek tries to portray itself as transparent but the level of detail it provides compared to other funds is minimal and designed to obfuscate. For instance, they provide headline information about their returns but when you compare their portfolio to their headline returns the numbers do not reconcile.

When you then ask about the discrepancy they refuse to answer and point you back to their headline return number. Other funds that I worked with in research may book, arranged conference call interviews, invited me to view their office and trading operations, and described in detail their decision making process about deciding to outsource asset management services.

Balding: I don’t think the sub-prime crisis makes the claims of 17% any more or less believable. I say that for two reasons.

First, Temasek is nearly 40 years old, so the impact of one year of recent returns will have only a minimal impact on the long term rate of return.

Second, global markets rebounded quite strongly after 2009, so unless Temasek was selling major portions at the bottom of the decline and then holding cash as market rebounded, Temasek most likely enjoyed the ride back up cancelling out at any returns. This is a highly unlikely scenario.

In short, I doubt the sub-prime crisis had any real impact on Temasek’s long term performance.

Balding: This information doesn’t really change anything and there is a simple explanation why. Temasek has been in existence since 1974, nearly 40 years now. Furthermore, it has only been since about 2000, that Temasek really made sustained and regular investments outside of Singapore.

Finally, it is just a law of mathematics that unless there are multiple years of enormously outsized returns, the long term rate of return won’t change much. For instance, if the long run rate of return is 17% over 38 years, even a bad year, won’t significantly move that 17% long run rate of return. To answer your question, I don’t think that information has a significant impact of my evaluation of the 17% returns claimed by Temasek.

Balding: If the 17% is true, though I doubt insider trading would raise it that much, I do believe that there are very real examples of the government favoring selected Temasek companies. By systematically favoring Temasek companies, the government of Singapore can significantly increase their profitability. Let me give you one simple example.

The government of Singapore gave SingTel a $1.5 billion SGD payment for the loss of its monopoly in the late 1990’s. Considering that the government gave SingTel the monopoly, took it public, remains its biggest shareholder, appoints management, regulates it, and negotiates the contract, this would seem like a clear conflict of interest and unnecessary to pay Singtel $1.5 billion SGD for the loss of its monopoly.

Time and time again, you can see the government favoring Temasek companies that would help it achieve growth rates if the 17% performance is true.

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New Asia Republic would like to extend its deepest gratitude to Dr Christopher Balding for the time he has taken to respond to our queries. Photo courtesy of Temasek Holdings.