Friday, December 19, 2008

'We know that this giant tsunami will pass. It will take some time, but it must pass. It will pass.'

Dec 19, 2008

Mr Khaw Boon Wan (below), the People's Action Party's first organising secretary, explains the effect of the global economic downturn on the investments of town councils during a 90-minute interview with The Straits Times

By Aaron Low

THESE are unprecedented times, Mr Khaw Boon Wan notes.

But in explaining the rationale for town councils' move into investments, he makes it clear that anyone concerned about how their funds are used must look at total performance of the investments rather than individual transactions.

And performance needs to be evaluated over longer timeframes.

But the fact is that no matter how financially savvy anyone is, the financial meltdown this year would have made any serious individual or institutional investor lose money, he points out.

He cites the example of Harvard's endowment fund, which reported a 30 per cent drop in its investment portfolio because of the crisis.

'These are some of the sharpest investors in town and in the world. They have outperformed markets so many times but still their portfolio has shrunk,' he tells Insight.

In fact, these unprecedented times have turned conventional financial wisdom upside down, he notes.

'The fact is that you begin to have all the major central bankers and governments doing absolutely extraordinary things, unconventional things, totally against their philosophies,' he says.

There is a real fear that if nothing is done, the world could slide into another Great Depression.

This fear is what has led to a crisis of confidence in the financial markets - and which in turn has made almost all investors lose money.

'So all serious investors all over the world would have lost money. How to avoid losing money?' he asks.

But providing perspective, and the need to take a longer-term view of developments, he adds: 'We know that this giant tsunami will pass. It will take some time but it must pass. It will pass.

'And the fact that the best brains - regulators, policyholders all over the world - are totally seized with trying to salvage the situation, and the unconventional solutions that they are crafting and continue to craft, at least give people confidence that, hopefully, this will not be a Great Depression Part Two, that we can avoid the worst of this.

'Of course, nobody can guarantee that. But the prospects are, I think, seemingly that the worst is over. But still, to come out of it will take some time.'

Mr Khaw, speaking in his capacity as the People's Action Party's first organising secretary, concedes that town councils have been no different from any other institution or individual who has invested in these times. Their funds have accumulated through the collection of service and conservancy charges and top-ups from the Government over the years.

There are funds for long-term needs - big-ticket items like cyclical work and repairs that have to be done every few years and are not cheap.

'That's the reason why funds have to be set aside for those long-term commitments, which we call the sinking fund. In accounting terms, it can be called capital reserve or depreciation accounts and all companies do that,' he said.

But as these needs are long-term, and councils have five-year or 10-year long-term plans, they are able to estimate their requirements and also know how much 'spare cash' there is - funds that are not needed for immediate use.

'So I can afford to invest in a five-year investment mandate or eight-year investment mandate or 10-year investment mandate and, of course, everything being equal, the longer the mandate, the better the returns because the fund manager has more scope to invest in longer-term investment products which are more interesting and give you higher returns.'

These decisions are not taken lightly.

'Those are more important decisions because you need expertise. You cannot just say, just common sense, because common sense may not work in this instance.'

Councils turn not to people who are mavericks or rogue traders, but to experts who are knowledgeable and trustworthy.

'And you need people like that. And because we are investing public money, we have a responsibility to make sure that it is prudently done. So the basic principle of prudence and conservatism underpins our investment strategy,' Mr Khaw explains.

Prudent investments

IN MR KHAW'S view and against the backdrop of the current global economic climate, the golden rule of investing - diversification - is no longer true for the moment, as no matter where funds are parked, whether in bonds or stocks or in different types of companies, the value of the investment will drop.

Take the Singapore Press Holdings (SPH) as an example of how fear has eroded the value of the company's share price, says Mr Khaw.

'Here's a company, absolutely strong fundamentals but just because of this whole loss of confidence globally, if you have invested in SPH shares, you will find your wealth shrunk by 30 per cent,' he says.

'One year ago, it was around $4.40. So now it's $3.20... So then you have a choice. Do you liquidate now? In other words, do you sell it and straightaway make a loss of 30 per cent, or do you hold on to it because all the top management funds, I think, (are) talking about...the prospect of SPH recovering, and exceeding $5 is strong. But of course not immediately.'

But the pessimism in the stock market does not mean town councils' investments are in danger of being wiped out.

In fact, the contrary is true, Mr Khaw says.

This is because prudent investments made by the 14 PAP-run town councils over the years have meant that the combined sinking fund of all the PAP town councils now stands at $2 billion.

Sinking funds are for long-term and more expensive estate improvement works.

Mr Khaw points out that the sinking funds in Sembawang Town Council had grown from $200 million five years ago to $280 million now, mainly because of its investment activities.

He said the town council had spare cash because it had made money in the past. Its funds have not been chipped away because 'overall we are still positive'.

'So I think the protection part is not an issue here, I think all funds are safe. It's just a matter of, well, in this climate you earn less than you used to earn.'

Losses won't spark hikes

HE ASSURES that PAP town councils will not raise service and conservancy charges as a result of the losses.

'Why should it be?' he says.

But he adds that conservancy fees are adjusted because of other factors, a major part of which are from manpower costs.

'So, over time, all those things will have to go up. Just like hospital fees. I cannot guarantee you hospital fees will stay forever. I can't. Unless you say you allow service to drop.'

Indeed, the town council investments have indirectly helped stabilise conservancy charges over the years, says Mr Khaw.

This is because part of the conservancy charges collected from residents goes into the sinking fund which pays for cyclical repairs that are done over longer intervals and which can be costly exercises.

Amounts from the sinking fund are then invested based on rules set by the National Development Ministry. These stipulate that not more than 35 per cent of the funds can be invested in non-government stocks, funds or securities.

Such investments help to grow the sinking fund and protect it against inflation, which would otherwise erode the purchasing power of the fund.

Without a sinking fund, town councils would have to go to residents and ask for large amounts every time major repair works have to be undertaken.

Says Mr Khaw: 'I think it's easier if you save some money every month rather than every 10th year, I come to you and say I want $1,000 from you now. Very hard!'

Another reason why residents should not worry about the losses is that the funds used to invest is 'spare cash' from the town councils' sinking funds that is not needed in the short term.

'And instead of money sitting there collecting dust, you try to invest; try to make some money out of it. But you know there'll be cycles. So some years are bad, but hopefully there are many more good years. So, on an overall basis, you still come out ahead.'

As such, the focus of investing these funds should be on how much funds have grown over a period of, say five to 10 years, rather than scrutinising them every other month.

'So long as you have the right people in charge and so long as these are real surpluses and are not immediately needed, that means they are meant for long have staying power.'

Rather than panicking now and liquidating assets into cash - and unless the entire financial system collapses - it is better to stay stuck in as Mr Khaw believes the 'giant tsunami' will pass.

Council funds are safe

LOOKING back at the episode involving losses by the PAP-run town councils, Mr Khaw says that there are several lessons that can be learnt.

One good thing that has come out of this crisis is that it has provided 'teaching moments' that will educate Singaporeans on range of subjects:

'I think along the way Singaporeans will get educated about investments, about returns, about risks, about the relationship with your local MP, about town councils' management which impacts your daily life, and therefore you legitimately have an interest to make sure it is well run, well managed.'

As for whether the episode could have been handled differently, Mr Khaw says, that, in hindsight, it is easy to criticise the town councils for how they managed the situation.

Would he have done it differently?

'I would have preferred much more communication; just openly share with people what you know, what you already know or what you don't know yet. And that is always helpful.'

But he defends the town councils against suggestions that they have not been transparent enough.

'It's absolutely transparent because this is not a secret society activity where there is secrecy and so on.'

He does not see the need to provide even more detailed and frequent updates because it may trigger an information overload.

'You have to also be aware that there's an info overload because once you start talking about funds of $200-odd million, there are a lot of transactions there and you cannot be going line by line, today this, tomorrow the other.'

And this attention to too much detail is what could cause people to miss the forest for the trees.

'I think this is what happened in the last few weeks, they keep on focusing on this Lehman product, forgetting about what about investment elsewhere,' he says.

The simple message he has for Singaporeans is this: 'Your funds are safe. Yes, there will be some losses in some individual transactions but, on an overall basis, the principal sum is there and and we've made profits in the previous years.'

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