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Higher risks but returns remain low

Financial market volatility low despite uncertainty, says GIC in latest report


The world is beset by great uncertainties, yet financial market volatility is very low - a sign that investors are complacent, GIC said in its latest report.

Its response has been to build a diversified and resilient portfolio to ensure capital and returns can be best protected over the long term - but this does not come easy, it noted.

In a feature article in its latest report, the sovereign wealth fund noted that statistical measures of volatility are extraordinarily low by historical standards.

"The current market environment features abundant liquidity and low yields, which have contributed to the suppression of volatility across equity markets."

This does not mean that uncertainty has been removed from the environment.

"Developments such as Brexit, the United States presidential election and heightened geopolitical tensions belie the sanguine view of market risk as conveyed by standard risk measures," GIC noted.

There is also great uncertainty in how technology is altering labour markets, driving income inequality and fuelling the rise of populism, for instance.

These uncertainties, which represent higher risk, should in theory lead to higher expected returns - and yet this, too, is not the case, GIC noted.

"In theory, higher risk goes hand in hand with higher expected returns as investors expect to be compensated more for investing in an asset for which the payoffs are less definite."

For example, investors expect to earn a "risk premium" or excess return by owning equities over bonds.

However, the outlook for risk assets features low returns. This unprecedented combination of low returns and low volatility with high uncertainty is particularly challenging, GIC said.

In response, it has aimed to ensure that its portfolio remains robust across a range of plausible scenarios.

GIC chief executive officer Lim Chow Kiat said: "Our way to deal with this kind of scenario is to build a portfolio that can be as resilient and robust as possible.

" We look at different possible outcomes, diversify our portfolio and we are more cautious."

He said the sovereign wealth fund has also had to work a lot harder to find assets with good long-term earnings potential.

"We have been more active in looking for such assets at reasonable prices. There are many good assets but if the price is too high, the returns will not be good," he noted.

It was this search, for example, that led GIC to become one of the first institutional investors in the world to begin investing in student housing, he said.

"We expect to continue to be active in the student housing market and at the same time will keep looking for other sectors," said Mr Lim.

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