A P: Time for active management

The Government of Singapore Investment Corporation (GIC) has been instrumental in converting Singapore into a vibrant regional fund management centre.

The Government of Singapore Investment Corporation (GIC) is one of the largest and most powerful fund management complexes in the world. It also has a reputation for being run very professionally, and having a high-quality talent pool. It is a unique organisation, managing one of the largest proprietary pools of capital in the world, which allows it to take large, contrarian and long-term oriented bets. The GIC is also a very sophisticated organisation investing across various asset classes like equities, fixed income, currencies and commodities and that too in all regions of the world.

The GIC has also been instrumental in converting Singapore into a vibrant regional fund management centre, through its policy of giving out fund management mandates for approximately 25 per cent of its total assets.

I talk of the GIC today because for the first time, the organisation has actually disclosed its long-term track record. At a recent celebration marking its 25th anniversary, the numbers were disclosed to the media for the first time. The GIC, over its 25-year history, has delivered a 9.5 per cent return p.a., which to my mind at least is a very strong number. Nine and a half per cent per annum over 25 years, with an asset allocation mix of only 40-50 per cent in equities, and the rest in bonds, alternative assets and property, is a very good performance indeed. More importantly, the organisation has delivered a return of 5.2 per cent over G-3 inflation, and thus not only preserved the purchasing power of the Singapore reserves but also significantly enhanced them. It has also achieved these numbers on an asset size of well over $100 billion. It just goes to show the type of returns one can generate even on very large pools of capital if you calibrate risk and return.

Given the clear success the GIC has had in fulfilling its mandate, is it not time that we in India looked at setting up something similar? Our foreign exchange reserves are now over $160 billion and growing. In 3-4 years, we could easily have reserves of close to $250 billion. If we are convinced that India's time has truly arrived, then there should be little risk of a run on these reserves and they should be stable and growing continuously. In the context of this being a stable pool of capital, should we not attempt to target higher returns with limited risk? Can we not treat this as a long-term proprietary pool of capital, and attempt to protect and grow its purchasing power a la Singapore? Do we really need to adopt the classic central banker approach of taking no risk and only investing the reserves in "riskless" government securities and treasuries? This approach may have been appropriate in the forex-starved environment of a pre-liberalisation India, but not today.

While I am sure the Reserve Bank of India is doing a good job within the mandate given to it, if your investment policy only allows you to invest in very low-risk assets, there is a limit to what you can do. If your only objective is to ensure no loss of nominal capital, you cannot go much beyond sovereign instruments.

I believe that the time has now come to accept that a significant portion of our reserves is now permanent, and thus we can treat them as long-term in nature and attempt to manage them for returns, not only safety of principal.

We can now think of setting up a new organisation, call it the Government of India Investment Corporation (GIIC)if you wish, and give it the mandate to manage a portion of our reserves with an objective to preserve and grow the purchasing power of this pool of capital. As soon as the mandate changes from capital preservation at any cost to growing the purchasing power of a pool of assets, the asset allocation will inevitably change to encompass global equities and corporate bonds.

Given the example of the GIC, even if this organisation were to be quite conservative in its asset allocation, it should be able to give us a pick-up in returns of at least 300-400 basis points (3-4 per cent) over the long term. This improvement of 300-400 basis points would be above the current yields we are generating on our foreign exchange assets, which are largely in sovereigns. Even if we were to move only $50 billion of our reserves into this new structure, a yield pick-up of this magnitude would generate an additional $2 billion of returns. Imagine that we could add almost Rs 10,000 crore in national wealth and that too on an annual basis by focusing on returns. Obviously, these additional returns accrue over the long term, and there could be years when returns are actually negative, but the greater volatility in returns should not matter, as this money is ours for the foreseeable future and there is no immediate need to draw down on it.

Beyond returns, the other obvious benefit would be in making Mumbai more of a regional financial centre. If we were to go down this path, obviously this new organisation will not have all the skills required to manage a global portfolio of equities and bonds in-house. One would have to start by farming out a large part of this pool of capital to external fund managers, who could be incentivised to set up shop in Mumbai, and train our people. Over time as more and more people return from overseas training and gather the required exposure and experience to global financial markets more of the assets can be managed internally. This will ensure that the skill and exposure levels resident in the country get enhanced over time. If we ensure that most of the money farmed out is managed from Mumbai, then you also ensure that Mumbai gets clearly established as a source of capital for the region, which it is not currently. You will set up a virtuous circle of increased interaction between Mumbai and other global financial capitals.

Most of Asia has now gone down this route of more aggressively managing reserves to ensure the protection and growth of real purchasing power; witness the setting up of GIC-like organisations in Korea, Taiwan and China, not to mention the Middle East. Is it not time that we in India also started thinking along similar lines? The increased returns clearly justify the increased risk.