The Value of External Managers

GIC was incorporated in 1981 and is wholly owned by the Government of Singapore. With well over $100 billion in assets, GIC aims to achieve a reasonable risk-adjusted rate of return above global inflation over a 20-year investment horizon, to preserve and enhance Singapore’s foreign reserves. The reserves provide a stream of income that can be spent or invested for the benefit of present and future generations.

Must be nice, but unfortunately, we do things somewhat differently in the states where Social Security will continue to add billions to the deficit and debt each year. 

But this isn’t another rant about our problems or our policies, recent described by Seth Klarman as, “untested, inflationary and eroding free market signals.”  Instead, this is a quick update on our investment philosophy, which evidently, is quite similar to that of GIC.

Ironically, our brief introduction to the Singapore Sovereign Wealth Fund commenced while performing due diligence on a new manager we were recently introduced to in New York.  Our new friend spent several years with GIC as Global Head of Macro and Global Head of Currencies, and we wanted to understand this experience and how it ultimately equipped him for the rigors of founding a new firm.  So in addition to several phone calls with members of the current GIC team and peers closely connected to the firm, we spent several hours reading publically available reports to gain some insight into this foreign investment manager.

Turns out, the investment philosophy at GIC is not so foreign at all.  In fact, their perspective on allocating capital mirrors our own thinking around external investments at Broyhill.  Below are a few selections from GIC which underscore why we are always so excited about investing with the partners we have selected and the benefits they provide to our own internal investment efforts and professional development.

The Value of External Managers:

  • Allocating funds to external managers has three strategic benefits: it diversifies the portfolio, it expands the investment opportunities available, and it deepens our understanding of financial markets.
  • We have built long-term relationships with our external managers, some of whom we have invested with for many years. These partnerships have helped us to gain insights into high-quality investment ideas and research, as well as industry best practices in the areas of investments and operations.
  • We view our external managers as partners. Our external managers must share our core investment philosophy that taking a long-term perspective enables an investor to earn superior risk-adjusted returns. We look for external managers who can maximize a portfolio’s total market value over market cycles while controlling the interim risks.
  • External managers have to justify their management fees by delivering superior performance net of fees. Additionally, some of our external managers operate in niche markets or employ an investment style or strategy beyond our current capabilities.
  • Our external managers complement our internal capabilities and bring other benefits. They share their market and investment insights with us. These insights benefit our macroeconomic forecasts and asset allocation research and sometimes challenge our own investment beliefs. Through our external managers, we have expanded our network of contacts, providing us with an important source of knowledge and experience. Sometimes our external managers refer co-investment deals to our investment teams. They also keep us informed about best practices and norms in areas such as risk management, trade operations and settlements, compliance and monitoring.

Investment Process:

  • Many contacts are obtained from our wide-ranging dialogue with market participants, including referrals from our market network and internal team. Before an investment is made, we carry out extensive due diligence on the manager. As part of the investment due diligence process, we conduct both quantitative and qualitative evaluations. We evaluate factors such as the external manager’s track record; its performance relative to its peers; its compatibility with our existing portfolio and our assessment of the manager’s team, investment process and attention to risk control.
  • Our goal in portfolio construction is to achieve a balanced portfolio that maximizes returns over the medium term while minimizing the risk of severe capital loss in periods of extreme market stress. Expected returns and risks are interconnected, so constructing the externally-managed portfolio requires good judgment to balance a variety of risks. Our allocation to different strategies is formulated through a clear understanding of the risks and returns inherent in each strategy.
  • We monitor our external managers closely, through regular update calls and meetings. We take a long-term view when assessing managers. In addition to consistent good performance, we look for a steady application of their investment philosophy and process throughout market cycles.

Conclusion:

  • While we have honed investing capabilities over the years, we have always benefited by learning from our peers and partners in the industry. We have built strong connections with our panel of external managers. They will continue to be a valuable source of not only returns, but also market views and understanding of industry best practices.
  • Although external managers can provide strong and diversified returns, outsourcing part of the portfolio inevitably adds further complexity to the overall portfolio. Therefore, we will continue to construct our externally-managed portfolio with a clear understanding of the benefits of using external managers, while paying close attention to risks.
  • Our approach to external management has evolved in step with our internal capabilities and needs. We continue to seek good managers who can complement our strengths and add value to the structure and performance of the portfolio.

Many asset managers today have built tremendous businesses by marketing “open architecture” or mimicking “the endowment model.”  Both are dependent upon the identification of talented investment managers within the constructs of a long term asset allocation policy.  Many firms have had great success with this philosophy. However, we think it’s notable that many of these “asset managers” have never actually managed money themselves.  One might wonder how then, they are able to consistently identify talent and truly understand the nature of the returns driving their elegant spreadsheets and models.

At the other end of the spectrum, there are still plenty of asset managers that choose to “go it alone” – constructing portfolios of individual stocks and bonds with nothing more than “proprietary” research and analysis.  This has worked unquestionably well for The Superinvestors of Graham-and-Doddsville, but most investors are not Warren Buffett.  They just think they are.

Rather than painting ourselves into a corner, we think an investment approach that takes the best of both worlds can provide investors with a robust edge over the competition.  Our external investments with like-minded, long-term investors complement our internal capabilities, expand our investable universe, and deepen our understanding of financial markets.



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