Friday, May 15, 2009

Transparency and Temasek: diversification, investments and a vote for Jim Rogers

Transparency and Temasek: diversification, investments and a vote for Jim Rogers

An area which I am particularly concerned about as a Singaporean citizen is transparency and accountability of certain decisions, particularly with regards to Singapore's investment strategies via Temasek and the Government Investment Corporation, or GIC. They have undeniably done a good job so far: look at Temasek's track record. It's really pretty decent, if lumpy, but as Buffett once said, I'd rather have a lumpy 15% than a smooth 12%. Especially since smooth returns are often a symptom of a Madoff-like Ponzi scheme

Despite Temasek's past brillance, I found it disturbing when their respective investments in Merrill (by Temasek), Citi and UBS (by GIC) were done extremely quickly, and at a disturbingly high price (to me, even at that time).

More disturbingly, it transpired today that Temasek had sold off its stake in Bank of America (which had acquired Merrill) in the first quarter of this year. The market timing is superbly bad: they bought at a high, and sold all the way to the bottom, and missed out on the rebound in prices from the bottom that occurred around March. They might pride themselves on their fundamental analysis, but from this it is fairly obvious that their understanding of market dynamics and market timing is sufficiently bad for this realized loss to occur, especially since they had emphasized that this was for a "long term investment". This episode reminds me of an ex-colleague who said, "a long term investment is a short term speculation gone bad", only that in this case it's both a long term investment AND a short term speculation gone horribly wrong...




If Temasek was any normal company, the shareholders might be roused by a Carl-Icahn-wannabe into an open shareholder revolt, demanding answers as to how this happened, why it happened, and how we can prevent this from happening again. This being Singapore, such calls for radical change are unlikely to be heard from the Singapore press (though to be fair, their money editor wrote a piece today asking Temasek to come clean). It is perhaps just as well that such demagogy is not typical, given that stupidity is the norm in mobs while relatively rarer in individuals. We should perhaps be more charitable: time alone will tell whether Temasek made the right or wrong choice with regards to divesting Bank of America in Q1 2009.


More at stake than just a single stake in an American bank


All the same, I do question Temasek's investment strategy and tactics, and wonder if there might be some mechanism to allow for greater checks and balances.
Prompted by the news of this recent divestment, I started looking at Temasek's website on their investments. It becomes fairly obvious that Temasek's bad call is symptomatic of a larger issue. For an investment company of that size (>US$100bn), Temasek is extremely concentrated in a single asset class (ok, maybe two asset classes, as they have an internal private equity fund as well), and lacks sufficient diversification across asset classes and across geographical regions. As a comparison, the much smaller Yale University endowment fund (US$28bn) has spread their assets across six different asset classes (excluding cash), including absolute return funds, private equity, and real assets (which is made up of real estate, oil and gas assets, and forestry).

The argument that I have heard for Temasek's concentrated portfolio is "higher risk, higher return", which sounds intuitively correct. But contrary to what people think, having more risk doesn't always translate into more return: the markets are full of occasions when there are asymmetric risk/reward situations, where sometimes risk is much larger than reward, or the reverse. That's the reason why portfolio diversification can actually increase your potential returns while reducing your risk, if done correctly.

Temasek's portfolio is diversified across different industrial sectors, but almost entirely concentrated in equities. In a longer run, an equity focus is a good idea, but there are times like Black Monday, when all equity markets become very highly correlated, which is why it is important to diversify significantly into other non-correlated asset classes, like hedge funds, private equity, venture capital etc. that are not correlated to your main market. Geographically, Temasek is focused primarily in Asia, US and Europe: Africa, Latin America and Russia are nowhere on the list, which is surprising given that the growth in these geographical regions have been significant, and the markets there have a weaker correlation than Asia, Europe and the US (which is Singapore's primary exposure). The opportunity cost of losing out on the growth in Africa, Russia and Latin America and the lost diversification benefits (from a risk perspective) cannot be overlooked. This lapse is also surprising given that Temasek's stated investment strategy of four themes overlaps with a number of excellent companies in Africa, Russia and Latin America.

Temasek might want to consider the kind of asset bucketing that was pioneered by David Swensen of Yale's endowment fund, but to go beyond the Yale model and look into managed futures and derivatives funds. If I were in Temasek's shoes, I would consider investing a few billion in joint venture funds with commodity trading advisors (CTAs, for short) that have a decent track record, as per this example that you can see from Abraham Trading, on a 50-50 equity basis. This overcomes the moral hazard of selling a call option to the CTAs (when you give them your money to invest on your behalf), but more importantly it also allows Temasek to groom a generation of traders with which to create its own diversified trading funds in the future.

It will also not be a bad idea for Temasek to explore creating a joint venture with Nassim Taleb's Black Swan investment fund, Universa Investments, to hedge part of our portfolio and to learn to properly hedge. This is especially the case, as most financial professionals have readily used the excuse of "these are unprecedented markets" to pardon their portfolio losses, whereas George Soros used the same reason to get out of retirement and make US$2.9 billion in 2007.

Greater transparency and more dialogue for Temasek's future trading strategy

To be fair, Temasek has been pretty upfront and transparent about their strategy so far. But when faced with portfolio losses of this magnitude, there needs to be some answers, and some honest dialogue in the days ahead of what should the path ahead be like. Arguably, Temasek has already taken the correct first step by having Chip Goodyear replace Ho Ching, which portends a professionalization of Temasek in the days to come.

But in addition to this, I think Temasek needs to include more professional investors on its Board of Directors (and not just company CEOs). As such, I vote to include Jim Rogers on Temasek's Board of Directors. We can maybe consider that to be Jim Roger's NS, and offer him a citizenship after that.

http://forums.delphiforums.com/sunkopitiam/messages?msg=29004.26

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