Asia Cannot Live By T-Notes Alone

Central banks are looking to diversify out of dollar bonds

For decades, asian governments have shoveled their foreign currency surpluses into U.S. Treasury bills and notes without much thought about investment returns. After all, the stability of their currencies -- and overall economic growth prospects -- have long depended on an ample supply of dollar-denominated reserves.

But now Asia is awash in record levels of foreign exchange, thanks to surging export growth. Asian central banks have amassed $1.6 trillion, or nearly 40% of the world's total reserves, most of it invested in U.S. Treasuries, the rest in euro or yen bonds. But low yields and potential losses from a sinking dollar are prompting governments from Bangkok to Seoul to consider alternatives to the T-note, including stocks, asset-backed bonds, and real estate. "It's essential these burgeoning assets be put to work more productively," says Prasenjit K. Basu, director of Singapore private research firm Robust Economic Analysis.

The latest country to start a major push toward diversification is South Korea, which in July will launch Korea Investment Corp. (KIC) with a mandate to invest $20 billion overseas. That's 10% of Korea's total of $205.8 billion in reserves -- the world's fourth-largest stash -- most of which is tucked away in U.S. Treasury notes and euro-denominated sovereign debt. "KIC's main purpose is to attract foreign talent and knowhow to help develop our financial industry," says a government official. "Improving returns of the assets is a secondary objective."

While Seoul is just starting to use its reserves more creatively, Singapore has been doing so for nearly 25 years. Indeed, almost all of Singapore's reserves, about $115 billion, are invested through a special state-owned asset management company called Government Investment Corp. (GIC). That puts it among the top global asset managers.

Although the state-owned company, whose titular head is board member and former Prime Minister Lee Kuan Yew, doesn't disclose details about most of its investments or its annual returns, GIC has a reputation in financial circles for matching the returns of many global asset management peers. That has made it an attractive model for other nations in the region. "Outside Singapore, few in Asia have had a clue about how to manage their growing reserves or to get better returns on them," says Jim Walker, chief Asia economist for CLSA Asia-Pacific Markets in Hong Kong.

The surge in reserves reflects a vast increase in revenue from exports, mostly to the U.S. When Asian companies repatriate the dollars they earn selling products overseas, their central banks exchange them for local currency. Central banks sometimes also buy up dollars on the market to slow the appreciation of their currencies. All those greenbacks can be sold back to shore up demand for the local currency -- and fend off a speculative attack. But most of the money remains invested in U.S. government bonds until those bonds mature, at which point it may simply be sunk into new bonds.


The dollar remains the world's preeminent reserve currency, and major accumulators such as China and Japan show little inclination to substantially reduce their dollar-denominated assets. To do so would undermine the value of their sizable portfolios of U.S. securities. But even those two nations are protectively shifting some assets into other currencies such as euros and, in China's case, using them to recapitalize troubled banks. Meanwhile, Malaysia and South Korea are looking into ways to diversify a bigger slice of their reserves. The goal is to protect the reserves from a further slide in the dollar -- which erodes their local currency value -- and also to earn better returns on them.

For Singapore's GIC, that means putting reserves to work in a variety of top-grade corporate and sovereign bonds, equities, real estate holdings, and private-equity placements spread across the globe. Company officials declined to comment on specific strategies, but they say about 20% of their investment capital is placed with outside managers. The publicly stated objective of GIC, which is run by Managing Director Lee Ek Tieng, a former Singaporean Finance Ministry official, is to outperform over three-year periods a composite index that tracks the asset classes in which it invests. In practice, the GIC says that works out to be just above the average rate of inflation in the U.S., Germany, and Japan. "That's not a very ambitious target," says Chew Ping, sovereign analyst with Standard & Poor's (MHP ) in Singapore.

To goose returns, GIC has become a player in real estate through its property arm, GIC RE. That unit has slowly been deepening its investments over the past decade in office blocks, malls, and hotels in North America, Europe, and North Asia. GIC RE now has more than $3 billion invested in Japan and South Korea, and in the U.S., GIC recently formed a $1.85 billion real estate investment trust with New York-based Tishman Speyer Properties. Last December it bought Star Tower -- South Korea's largest office building -- from Dallas-based Lone Star Fund for $860 million. That's $230 million above what Lone Star paid in 2001.

The Koreans have taken note of GIC's increasingly high profile. But the Bank of Korea will not allow investment in any real estate, unlisted equities, or non-investment-grade securities. Another key difference: The Korean version will outsource up to 90% of the money to local and foreign asset managers. What's more, the government is inviting foreign managers to apply for top posts. "We want KIC to play a key role," says Choi Joong Kyung, the Finance Ministry's director-general of international finance. "We want to turn Korea into a regional financial hub specializing in fund management."

Malaysia is debating whether to follow suit by setting up a similar investment management body for its reserves. Five years ago, as the Asian financial crisis wound down, the country had just $20 billion in reserves and was struggling to keep its hard peg to the dollar intact. Now, with foreign reserves topping $75 billion, Malaysia is mulling ways to manage its reserves more actively than plowing them into T-notes, as it does now. Taiwan and Thailand are also studying ways of lowering their exposure to U.S. bonds.

For their part, global fund managers are eagerly awaiting more state-owned investment companies in Asia. "By outsourcing part of their portfolio to asset managers, Asian central banks can minimize risk, maximize returns, and diversify," says Tan Chong Koay, head of Pheim Asset Management in Singapore, which manages more than $800 million, including a small portfolio for the GIC. Indeed, as long as Asia's reserves keep building, the days of passive management seem numbered.

By Assif Shameen in Singapore, with Moon Ihlwan in Seoul

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