GIC Fees are More than a Hedge Fund?

The important thing about Singaporean public finances and sovereign wealth funds that even most Singaporeans fail to grasp is their absolute centrality to most any economic and even many social issues.  You simply cannot discuss most any major issue in Singapore today without weighing the importance of Temasek, GIC, and Singaporean public finances.

It was with great interest that I recently saw an article entitled “Why Our Saving Rates are Among Highest in the World but We Have No Money for Retirement?”.  The well intentioned author lays the blame primarily at the feet Singapore’s “transformation into an open economy” and “heavy reliance on large multinationals and imported workforce…” but overlooks the most important factor, the role of Singaporean financial policy and specifically GIC and Temasek.  Let me explain.

Let’s take a very simple example to illustrate the point.  Let’s assume that a Singaporean worker started earning an average Singaporean wage in 1980 and earned an average wage every year through 2011 according to IMF and Singapore Ministry of Finance data.  Every year the employee and the employer paid the mandated CPF contributions.  To further simplify, and be generous to the Singaporean government, let’s assume that the savings are earning the highest rate of return of the CPF contributions.  For instance, I assume that current CPF savings are earning 4% rather than 2.5%.  This saves the difficulty of estimating the weighted return percentage and is very generous to the Singaporean government. (I want to emphasize that I am fully aware that 4% is not the primary rate but rather 2.5%.  I want to be extremely generous to the government as the numbers are still quite different).

Making an average Singaporean wage, an average worker would have earned a total of $898,227 SGD in wages over that period and contributed $318,871 SGD between employee and employer contributions to a CPF account.  Interest growth would total $218,241 bringing the accumulated savings of the average employee to $537,112 SGD, assuming that the money has not been withdrawn for something such as the purchase of a flat.  This is not an insignificant amount of money by any means but it fails to tell you the whole story.

GIC, Temasek, and government linked companies have depended heavily on the low priced capital they could obtain.  This was mandated by the government who required savers to save their money with the government and “guaranteed” savers a low rate of return.  According to current data, the inflated assumption of a 4% guaranteed return does not even keep pace with inflation.  Consequently, the Singaporean saver who is forced to save with the government is implicitly losing money and subsidizing government investments and government linked companies.

How much then has the low interest rates mandated by the government in the CPF cost the “average” Singaporean?  Let’s assume instead of receiving the “guaranteed” CPF rate of return that savers instead earned the GIC long term average of 7%. (I am aware that GIC reports in USD but this is only for illustrative purposes and 7-8% is the long term return on equities in virtually all stock markets).  The “average” Singaporean would now have saved $798,806 SGD.  In other words, if CPF savers only earned the GIC rate of 7% rather than the CPF rate, the “average” Singaporean would be $261,694 wealthier.  Furthermore, if we took the unrealistic assumption that the “average” Singaporean earned a Temasek rate of return, they would be sitting on $4.5 million SGD a difference of $3,984,258 SGD from the current balance.

Most disturbingly are the implicitly high costs associated with the GIC and Temasek financial industrial complex.  Let’s again take a simple example.  Let’s assume that the difference between what a saver earns with CPF and 7% is the GIC “fee”.  In other words, if GIC earns 7% and CPF pays out 4%, again a simple example, then the GIC “fee” is equal to 3%.  The GIC “fee” is $261,694 SGD but this again only partially tells the story.  In the CPF system, the saver, along with employer contributions, has contributed $318,871 SGD and received $218,241 SGD in “guaranteed” interest.  However, this is $43,452 SGD less than the GIC “fee”.  In other words, the CPF saver has paid more to GIC than they have received in “guaranteed” interest.

There is one more way to think about the GIC fee relative to other asset managers.  Hedge fund managers are generally the most expensive asset managers in the financial services world.  Though not all hedge fund managers charge the same fee, it is pretty standard for hedge fund managers to charge what is called “2 and 20”.  That means there is a 2% of assets under management yearly fee and 20% of all profits earned.  To use a simple example, let’s assume you give a hedge fund manager $100 million SGD and he doubles your money to $200 million in one year.  If the 2% assets under management fee was taken at the beginning, the hedge fund manager would earn roughly $22 million ($2 million + $20 million.  Again, this is using very simple numbers and calculations).

Now let’s apply that same compensation structure a CPF saver.  An average hedge fund manager who earned the GIC rate of returned for our “average” Singaporean would have charged $233,111 SGD or $28,582 SGD less than GIC.  In other words, Singaporeans are paying more for GIC than the average hedge fund manager.  Finally, many hedge funds have something called a “hurdle rate”.  A “hurdle rate” is the rate of return the manager must exceed before earning the 20% of profits incentive.  For instance, a common hurdle rate is 5% so that any rate of return less than 5% is not subject to the 20% of profits fee.  Singaporean CPF savers are paying more than the average hedge fund manager to earn a “guaranteed” 2.5-4%.

While the concern over the lack of savings as many Singaporean approach old age is understandable, it is important to understand how this fits together with the already noted concerns about investment returns from Temasek and GIC.  On top of the extremely low rates of return Singaporeans are by law required to earn, they are paying exorbitant implicit fees even if we assume that the rates of return declared by GIC and Temasek are accurate.

Singaporeans have every right to be interested in GIC and Temasek financial management as it is your money.

Note: You can find a spreadsheet detailing the calculations here.  This should not be taken as financial or investment advice in anyway.  Finally, this of course does not account for all the details of life and is a simple calculation based upon public data about Singaporean wages, savings, and rates of returns and is not intended to account for every possible detail or variable one may encounter in the course of their life such as using CPF money to purchase a flat.

Temasek and the Case of the Undervalued Assets

I am amused and intrigued by people who have no understanding of the implications of their own arguments or do not carefully read what I have written.  In his “rebuttal of a rebuttal”, Mrs. Snook further attempts to convince myself and others about the correctness of her position that Temasek undervalued assets when it received them from the Singapore government therefore allowing Temasek to earn 17%.  Let us take a minute and explore his position and its importance.

Let me begin by clearly stating: the analysis of Temasek receiving undervalued assets to boost their claimed returns is entirely true.  Read my previous rebuttal (and related posts about Temasek accounting here and here) on the matter and you will clearly see that I never disagree with her or rebut her facts.  (Expecting her to respond as she did, I was kind of saving this part in reserve.  My apologies if that means I played a little dirty).  The only thing that I do is warn her about the implications of what her argument means.  Now let’s explore the facts and additional implications of what Temasek receiving undervalued assets means.

A basic argument is made about the original legacy holdings of Temasek with a simple illustration.  If the owner of a $1 million in financial assets transfers them to a holding company that they own at a nominal value of $100, nothing has changed.  The original owner of the assets, owns them, which owns the assets so there has been no change in the wealth of the owner.  The same argument is made about Temasek companies transferred from the government.  As is written “it was just an administrative exercise with no implications for the tax payer or citizen….I now own a company which owns $1 million in shares.  I have lost nothing.  I am still a freaking millionaire.”  As elegantly freaking stated as that is, let’s examine this claim closer.

First, this poorly constructed analogy overlooks the implications of how returns are claimed.  Let’s assume the owner of $1 million in unlisted financial assets, as the Singapore government was in 1974,  transfers its ownership to a company she owns for a nominal value of $100.  There is no change in wealth.  However, one year later, the owner cannot go out and claim that his company has an annual return of 999,900%!  This would be considered absurd by everyone who knew how that return was calculated.  Yet this is exactly what is claimed.  When Temasek receives assets at a “zero or nominal value” which are worth significantly more and then claims high returns, this is not a true or accurate picture of its actual performance.

Second, the reason I agree so strongly with the theory that Temasek is receiving undervalued assets is that purchasing or receiving undervalued assets is one of the best ways to cover up investment losses.  Let’s take a hypothetical situation.  The owner of the $1 million in unlisted assets transfers it to her new investment company at a nominal value of $100 and convinces her grandmother to give her some money to invest in the stock market.  Let’s assume, hypothetically of course, this new investment mogul guarantees Grandma a return of say 2.5% on her investment of $10,000.  This talented CEO takes this $10,100 into the stock market and let’s assume she buys some bank stock.  Then assume that the bank stock bought by this investment genius declines in value to say $5,000 a loss of 50.5% at which point it is sold.  Rather than going and telling Grandma she lost a lot of money, this talented investment guru revalues the unlisted assets from $100 to $6,010.  The official capital is only $5,000 but after revaluing the unlisted assets, the firm value is $11,010 allowing the new firm to declare a 10% return.  Grandma is impressed and keeps investing with her talented offspring.  This firm with the enormously undervalued assets as a cushion, can endure a lot of investment losses before encountering problems.

The question then becomes has this undervaluation of assets acquired or received by Temasek actually taken place and has the tax payer been hurt by this practice?

Due to the lack of data and their refusal to release the data, we cannot analyze in great detail the value of the assets transferred from the Singapore government at Temasek’s inception.  However, given the number of companies that were transferred, the aggregate value they were transferred at, and their size, it is quite probable they were significantly under valued when transferred to Temasek.  This would be a good start to many years of over stating returns and covering up losses.

Worryingly, this pattern of the Singapore government providing or selling Temasek significantly undervalued assets continues to this day.  There are two recent and obvious examples of how this behavior which is used to pad Temasek returns and harm the tax payer.  First, the Singapore government is paying $1.1 billion SGD to purchase buses for the SMRT.  The problem with this arrangement is that SMRT is a publicly listed, private company owned by Temasek that declared a $120 million SGD annual profit for the year ending March 31, 2012.  The government of Singapore is obviously subsidizing the profits of a Temasek company by transferring public assets to a private company incurring a tax payer loss.  To put this arrangement in perspective, if SMRT had to pay a 10 year bond with annual payment at a 4% interest rate on the $1.1 billion SGD in buses: it would pay $136 million SGD in principal and interest costs making its yearly profit disappear.  Given this information, it seems highly unlikely SMRT would have a $2 billion SGD market capitalization if the Singapore government was not subsidizing Temasek profits by billing the taxpayer for the capital used by a private company.

Second, as was pointed out by Steve Wu, Temasek with the help of a $3.2 billion SGD capital injection from the Singapore Ministry of Finance paid $3.2 SGD billion to acquire Changi airport.  This transaction is notable for a few reasons.  For instance, according to one document from Changi Airport, the government since the late 1970’s has invested approximately $5.68 billion SGD.  This implies that in pure dollar terms, the Singapore taxpayer lost approximately $2.5 billion SGD.  If we however assume, a purely hypothetical return on these airport investments by the government of 5% or 17%, the Singapore tax payer would have had an asset worth $13.3 billion or $202 billion respectively.  If the airport “investment” by the government earned a low yielding 5%, the Singapore taxpayer would have lost $10.1 billion SGD and if it earned the Temasek rate of return an astounding $198.8 billion loss.

Furthermore, by numerous valuation methods, it appears that the Changi Airport was significantly undervalued.  For instance, in its first full year of operation, the Changi Airport group earned $337 million SGD.  That is a 10.5% rate of return an incredible return for an airport.  Its profits ending 2012 was $553 million a 17% cash flow rate of return while the tax payer incurred a $2.5 billion SGD loss.  Temasek obviously received a sweetheart deal in acquiring Changi Airport at the expense of the tax payer.

To briefly recap the implications of receiving assets at “zero or nominal cost”.  First, Singapore tax payers are suffering losses by subsidizing Temasek profits.  Second, Singapore and Temasek are engaging in Mickey Mouse accounting.  Third, Temasek returns are inflated by the “zero or nominal cost” assets it received.  Fourth, Temasek accounting does not consider the cost of capital.

I completely agree that Temasek and its subsidiaries are receiving capital and companies at “zero or nominal cost”.  Unfortunately, this has disastrous and chilling implications for Singapore and Temasek.



Rebutting Nonsense: The Implications of “Zero or Nominal Cost”

I was recently notified of a rebuttal to some of my writings and specifically attempting to clarify how Temasek Holdings has earned 17% annually since 1974 as they claim.  The author claims that Temasek investment returns are entirely reasonable because Temasek received these companies at “zero or nominal cost”.  Consequently, earning 17% annually is relatively easy given the low initial valuation.  I will begin by discussing the implications of what the author claims and then in a later piece move to analyzing if what the author claims actually happened.

The Implications:

  1. Despite the author writing that I was “hinting that the returns are unbelievable and must be the result of Mickey Mouse accounting by TH”, the author states that the returns are unbelievable and are the result of Mickey Mouse accounting.  Let me explain.  The author correctly notes that the government of Singapore “started certain enterprises” in the 60’s and 70’s but then transferred those holdings to Temasek at “zero or nominal cost”.  Ask yourself this: when the government of Singapore started these capital intensive enterprises in shipping and airlines which required large investments, did it start them at “zero or nominal cost”?  Definitely not.  The government invested large amounts of money to start those companies but then transferred those assets to Temasek well below value, if what the author claims happened.  The first implication: the government is absorbing significant losses to start companies with large initial investments and subsidizing the profits of Temasek by transferring these corporate assets at “zero or nominal cost” incurring a loss for the government.
  2. The second implication of the authors claims: Temasek is engaging is Mickey Mouse accounting.  The author claims that the government of Singapore can transfer companies to Temasek at “zero or nominal cost” because these were not publicly traded companies at the time.  That is incorrect.  Just because these companies were not publicly listed does not mean that Singapore and Temasek can value the transfer of assets at “zero or nominal cost” or whatever value it wants.  As the primary or sole shareholder, those assets even in the absence of a public market, the government should have transferred those assets to Temasek based upon some measure of historical cost.  Let’s take a simple example.  If the government of Singapore creates the Acme Manufacturing company and invests $1 billion SGD and is the only or the majority shareholder, it should transfer the Acme company to Temasek based upon some value of the historical cost after accounting for profit and loss of the company say $1.1 billion SGD if the company made a profit.  The Singapore government cannot invest $1 billion SGD and then transfer that $1 billion SGD asset to Temasek at “zero or nominal cost” because it wants to artificially boost their returns.  That is truly Mickey Mouse accounting.
  3. The third implication of the authors claims:  Temasek returns claims are only “accounting” returns and not actual returns.  Just as Temasek declared a significant profit from its sale of Virgin Atlantic despite purchasing the stake for $1.65 billion SGD and selling it for $360 million, the author is saying the same thing about all Temasek returns.  By transferring the assets at “zero or nominal cost” as the author claims, this significantly increases Temasek’s accounting returns  but lowers the actual returns.  Let’s take a simple example.  Let’s assume that the government of Singapore spends $100 million SGD to create Acme Manufacturing, transfers it to Temasek at “zero or nominal cost” of say $50 million SGD, and Temasek then takes it public after which the market capitalization is let’s say $100 million.  Temasek enjoys a $50 million SGD profit and declares a return of 100%.  If Temasek receives the asset for $1 million SGD its profit is $99 million SGD and it declares a return of 9,900%!  The Singapore taxpayer however, suffers an offsetting loss of $50 million SGD (or $99 million) to subsidize Temasek “returns”.  In other words, the author is saying Temasek returns are inaccurate and should be considered accounting returns similar to declaring a profit after selling an asset for $360 million purchased for $1.65 billion.
  4. The fourth implication of what the author says: is that Temasek accounting does consider the cost of the capital.  This might be the most damaging and concerning implication.  Just as employers pay employees in the form of wages, companies have to pay and account for the cost of capital.  Capital may be a financial asset like stock in a company or a machine used to make things.  However, companies must account for their cost of capital.  A bank with deposits has to pay its depositors a small amount of interest.  A real estate development firm typically borrows money to builds a new apartment building or mall and it pays interest to a bank.  If Temasek is receiving assets for nothing then of course their returns should be enormous.  Let’s return to Acme Manufacturing for a moment.  What if they received their building and machines for free and didn’t have to pay for the cost of the building and machines?  Of course they would make a lot of money.  They should make a lot of money.  The author of this piece is stating that Temasek and other companies are not paying for their capital.  That is an enormous problem.

To briefly recap what this author has stated.  First, Singapore tax payers are suffering losses by subsidizing Temasek profits.  Second, Singapore and Temasek are engaging in Mickey Mouse accounting.  Third, Temasek returns are inflated by the “zero or nominal cost” assets it received.  Fourth, Temasek accounting does not consider the cost of capital.  Mind you this is what this anonymous author has said by arguing assets are transferred at “zero or nominal cost”.  Their argument not mine.

As I have repeatedly said, Temasek and Singapore have created an enormous problem for themselves.  If they try to tell the truth in one area, the enormity of the deception increases in other areas.  Today, I have focused only on the implications and arguments made by this anonymous author.  Next week I will examine what the data shows about whether what this author says is true.

Update: Thanks to a loyal reader for catching a small typo.