Today’s challenging climate has led diversified investors like GIC, Singapore’s sovereign wealth fund, to explore different portfolio construction approaches to build resilience. Grace Qiu and Ding Li, both Senior Vice Presidents of Total Portfolio Allocation and Policy at GIC, discussed their new research conducted in collaboration with various asset managers, at the Trust Investor Symposium.
Before diving into the articles, Li outlined how three key elements go into portfolio construction: risk, return, and diversification. He said all assets are likely to have lower returns in the current market, creating a challenge for investors looking to achieve their goals. This makes diversification even more important, especially given the growing correlation between stocks and bonds. He added that traditional portfolios are most likely to suffer in a stagflation regime.
Delegates also learned more about GIC’s approach to diversification across different asset classes and geographies.
GIC’s investment framework is based on two layers comprising the Strategic Portfolio, which targets long-term inflation-adjusted returns, and the Active Portfolio, which consists of active skill-based strategies. The latter is managed by internal and external managers and aims to add value while mitigating systemic risk. Active strategies are funded by the policy portfolio, Qiu (pictured) explained.
Qiu noted that investing in private markets supports diversification and boosts returns, but carries real liquidity risk.
In collaboration with PGIM, GIC published an article entitled “Building a better portfolio, balancing performance and liquidity”, on how to measure portfolio liquidity.
The framework played a role in shaping GIC’s exposure to private markets via a balance sheet simulation based on the investor’s short-term and long-term liquidity profile. This simulation allowed GIC to take liquidity requests into account in the risk management of its portfolio.
Li explained that as investors seek inflation-proof returns and diversification, and private market allocations continue to grow, liquidity has become a priority. He explained the importance of finding a comfortable level of liquidity risk and warned that cash flows are not always constant in private markets.
Elsewhere, Li noted that maintaining strategic goals in private markets is also a challenge, requiring a commitment to continue deploying capital to senior executives.
Li suggested that investors capture the different components that will impact liquidity through a top-down analysis of asset allocation and capital market assumptions, as well as the bottom-up needs of GPs and healthcare managers. wallet. This would indicate how capital should be deployed and the corresponding levels of commitment. From this position, investors will be able to quantify their liquidity needs, thereby reducing the risk of not meeting capital calls and liquidity requests, as well as the resulting reputational risk.
Diversification into emerging markets
In another paper, GIC worked with PIMCO to explore building a regionally balanced emerging markets portfolio. He found that investors should invest broadly in emerging markets across different geographies and risk factors.
“Don’t leave those choices to the index providers; design your portfolio granularly and deliberately,” Qiu said. Leaving emerging market allocations to index providers risks leading to an imbalanced allocation in terms of risk and region, with indices often being dominated by Asian public stocks.
“Diversification is the only free lunch in finance,” she reminded delegates.
Qiu also noted that investing in emerging markets is an important source of return despite the higher degree of uncertainty associated with it. It usually has a lag or tail and often goes through boom and bust cycles, she explained. Rather than adopting one strategy over another, Qiu said the key was to build a multi-asset allocation beyond public stocks, adding that investors should “allocate granularly.”
She also suggested that skilled, high-conviction investors can add value through a dynamic overlay on their long-term strategic asset allocation to emerging markets.
Referring to a third article, co-authored with Blackrock, Li explained how GIC factors in uncertain macroeconomic scenarios into its portfolio construction processes.
The idea is based on building a portfolio with a more balanced outcome, and compared to an alternative approach, focusing on better management of negative outcomes where diversification is also key. Examples include investing in US equities to balance exposure to Chinese equities and increasing investment in real estate to counter stagflation.
Qiu also highlighted GIC’s ongoing work with MSCI to explore the impact of macroeconomic risk on long-term asset returns. The document provides a consistent framework for all asset classes and will be released in the second half of this year.
Qiu and Li concluded that investors should not rely on a single toolkit for diversification and stressed the importance of geographic diversification given the current geopolitical tensions. Additionally, to address the risk of stagflation, investors should consider portfolios that include inflation-linked bonds, gold and commodities, as well as private real estate assets.