GIC: Smoke & mirrors

In Accounting, Corporate governance, GIC, Political governance on 27/09/2011 at 3:21 pm

No, this is not a rant abt GIC’s performance or how it misleads the public abt its performance. It’s about how its inability or unwillingness to communicate with us, the public, can be self-defeating, leading to more questions being asked, especially on why it keeps relying on spin rather than facts, as illustrated by this media statement from GIC.

In a statement to the media last week, the Ministry of Finance said, How well GIC performs is not a secret. Its mandate is to preserve and enhance the international purchasing power of the reserves over the long term. Hence, it publishes its 20-year annualised real rate of return.

GIC also reports its returns over five- and 10-year periods as intermediate measures of its performance.

 GIC’s Performance as per annual report

Period Government’s nominal rates of return in US$ for period ended 31 March 2011 (%) 
5-Year 6.3
10-Year 7.4
20-Year 7.2

Well its performance might be as well be secret.

The problem is that these performance numbers raise questions on their methodolgy, to which answers are not available. I will only raise one issue, but this one issue will take acres of space. TOC has raised other less technical issues.

My grumble is that there is no disclosure on whether the functional currency is US$ or S$. By “functional currency”, an accountant means the currency in which the accouts are prepared. We only know that the returns are presented in US$, the presentational currency. This does not imply that the functional currency is US$.

If the accounting of the funds under mgt are done in S$, the performance results would have included the exchange loss arising from the US$ depreciation against the S$. So if its functional currency is S$, but its presentation currency is US$, then all exchange losses arising from US$ depreciation against the S$ will have been taken into account.

If however if the  functional currency is US$, then its US$ denominated assets and US$ investment income will not be impacted by US$/S$ movements. And any analysis would have to take US$ depreciation into account.

The differences can be great. (Please click “Read more” to read the article in full, if you are reading from the Home page. There is a necessarily long-winded example to illustrate what I’m trying to say.)   

A rant about GIC and our CPF monies contained a passage which seems to make a lot of sense.

… So a question one might ask would be, what are GIC’s returns if they were converted to SGD? GIC reports its performance in terms of real annualised returns over global inflation, but that is quite irrelevant if the main concern is over whether GIC is able to generate sufficient returns to pay interest on CPF deposits. The USD-SGD exchange rate (as well as Singapore’s inflation rate) matters more than the global inflation rate (however that is calculated) since ultimately interest CPF deposits are credited in terms of SGD.

Is GIC able to pay off CPF deposits solely by its reported investment returns? Let’s take a look.

Take the five year period. The reported annualised nominal rate of return in USD is 6.3%, which implies that GIC’s enjoyed a 31.5% return over a period of 5 years. A check with Google Finance showed that from 31st March 2006 to 31st March 2011, the USD  fell from S$1.6183 to S$1.26, or a depreciation of 22.14%. That means over the past five years, the nominal rate of return in SGD is 31.5% – 22.14% = 9.36%. This equates to a nominal compounded growth rate of merely 1.8% over the last 5 years.

Now the minimum CPF interest rate as mandated by the CPF Act is 2.5%. How is GIC going to pay off interest on CPF deposits given its below par performance in terms of SGD? Not to mention the fact while the interest on the CPF Ordinary Account is 2.5%, the other CPF account pays a higher rate of interest at 4%.

Since GIC provided the numbers for their rolling annualied 10 and 20 year rate as well, one can perform the same set of calculations to yield the following numbers. GIC’s CAGR in SGD for the 10 and 20-year period period is 3.7% and  3.89% respectively. Historical forex rates may be found here. From this it looks like over the years, the strengthening Sing dollar has made it more difficult for GIC to credit interest on CPF deposits through overseas investment returns alone. (Note: The interest rate on CPF OA was fixed at 2.5% since 1999; it was higher in the earlier 1990s, see data here)

This person would be correct it the functional currency is US$. If it is S$, he would be wrong because his analysis is double counting the exchange loss. The difference is huge.

 Difference in Returns

Period GIC’s returns as per annual report (%) Blogger’s returns calculations taking into account US$ depreciation (%)
5-Year 6.3 1.8
10-Year 7.4 3.7
20-Year 7.2 3.89

That GIC shows its performance in US$ terms, does not mean that its functional currency is US$.

What I’m trying to show is that by not revealing its functional currency, GIC could be unnecesarily making S’poreans unnecessarily suspicious abt its performance. Of course, if the returns are that bad, as per the analysis above, then there is a reason why GIC and the government communicate the way they do.

  1. No need to write or ask so much lah. If after USD depreciated 30.4% against SGD over past 10 years, and still present in USD without saying that all forex movements have been accounted for, or that they have hedged the portfolio back to SGD, it simply means that the functional currency is USD lah.

    That’s why CPF interest rate for SMRA will be lowered from 1st Jan 2012 to average yield of 10-yr SGS + 1%, which is now barely 2.7% thanks to the upheaval in financial markets (the latest yield for 10-yr SGS is now 1.67%).

    This new interest rate formula will also be applied as internal bonus rate for the CPF Life annuity.

    If GIC performance continues the way it does, then CPF Act may be amended yet again to lower the threshold for CPF-OA to below 2.5%.

  2. I agree with xyz that the functional and presentation currencies have to be one and the same assuming that they are not deceiving the public.

    The recent $7B loss in UBS alone in a $100B GIC amounts to 7% of asset. Based on the blogger’s calculation, the nominal rate of return in SGD over the last 5 years would be 9.36%-7%=2.36%, which is not sufficient to pay for even one year’s CPF interest!

    I don’t understand why GIC can’t be as transparent as Buffett, Harvard, and CalPERS.

    Once you consider the local inflation number (20%?? over 5 years), you should fire the management of GIC!

  3. I would be interested to know the IRR of the GIC portfolio. This method of calculation would take into account cash inflows and outflows of the GIC portfolio.

    I suspect that the reported performance numbers were calculated in the usual way, i.e. time-weighted, and therefore any flow impacts of the portfolio will not be factored in.

    It is possible for a time-weighted return to be positive while the dollar-weighted return or IRR will be negative.

  4. I don’t think its worth speculating that the CPF board doesn’t have enough money to pay out the 2.5%. That’s probably a very long shot.

    They can simply just increase the money supply and add free digits to everyone’s account.

    Same thing with the exchange rate since it is not a free float. Most citizens don’t have a clue about inflation anyway.

  5. Still lurking around various blogs occasionally. Trying to avoid Singapore-related posts, but I still enjoy discussing finance.

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