Temasek Holdings, the investment arm of the Singapore government, posted a record profit of S$18 billion ($12.9 billion) in the fiscal year ended March 2008, but sees limited opportunities in the coming years.

Temasek chairman S Dhanabalan says volatility remains high and further contagion is expected in the US, Europe and Asia. He expects the fallout of the credit crisis to continue to dampen the global economy over the next 24 months, with sharply escalated oil and food prices beginning to test inflation expectations.

ôWe are concerned with the emerging risks of stagflation. This presents huge socio-political as well as economic risks in the next three to five years. Opportunities may be limited in such a scenario,ö Dhanabalan says in the Temasek Review 2008 released Tuesday.

Temasek will continue to broadly focus on Asia, but it is also setting up offices in Mexico and Brazil to deepen and broaden its exposure to Latin America, Dhanabalan says. Earlier this month, former Morgan Stanley banker Michael Dee joined Temasek as its senior managing director for international investments in line with a bid to expand overseas investments.

Temasek achieved its record profit in its latest fiscal year on the back of strong operating performance of its portfolio companies and healthy realised gains from its direct investment activities. Its portfolio grew to S$185 billion ($132 billion), an increase of 13% from S$164 billion the previous year. Shareholder equity increased 26% to S$144 billion over the same period. The increase in portfolio size was partly due to a new capital injection of S$10 billion by the Ministry of Finance, Temasek's shareholder, as part of its asset reallocation.

Temasek delivered a one-year total shareholder return (TSR) of 7% by market value, including dividends. TSR by shareholder funds was at 17% for the year. Wealth added (or economic profit) for the year was S$6 billion below its cost of capital hurdle, which Temasek attributes to the sharp marked-to-market corrections in global markets in the first quarter of 2008. The firm says the five-year cumulative wealth added was a ôhealthyö S$60 billion.

Dee, who has been on board for just a few weeks, says Temasek was prepared to stay in the sidelines over the past year, which instead turned out to be an eventful one for the investment firm. Temasek continued to build the foundation for long-term returns as it actively rebalanced its portfolio, he says.

Indeed, it was an active year for Temasek on the investment front. The firm made S$32 billion in new investments and divested S$17 billion of its portfolio in the fiscal year ending March 2008, compared to S$16 billion in investments and S$5 billion of divestments in the previous year.

For the first time in Temasek's history, net investments outside Asia, valued at S$10 billion, exceeded net investments in Asia, valued at S$5 billion. In the preceding five years, Temasek had invested a net S$26 billion in Asia and just under S$1 billion of net investments in non-Asian economies.

ôLast year our ratio of investments in Asia to investments outside of Asia was approximately two-and-a-half to one. I expect this statistic to be volatile over time, as we do not target that number from a management perspective,ö Dee says. ôWe want to be available and capable of executing high quality investments that we believe to have excellent value, no matter where they are in the world. If they happen to be outside of Asia one year, so be it. If not, we will invest where we see the best value.ö

Temasek's underlying asset exposure to economies outside Asia increased from 22% of its portfolio to 26%, bolstered by investments such as Merrill Lynch in the US and investments in Latin America and Russia. Portfolio exposure to Singapore fell for the first time from S$62 billion to S$60 billion, partly due to the sale of Tuas Power, and continued to account for a smaller part of a growing portfolio û 33% in financial year ended March 2008 compared to 38% and 44% in financial years ended March 2007 and March 2006, respectively. Exposure to Asia (excluding Singapore and Japan) was 41% from 40% a year ago, despite S$12 billion worth of divestments.

Investments made since 2002, when Temasek reshaped its portfolio significantly to increase its exposure to emerging Asia, have delivered a six-year annualised return of 32% compared to the 16% delivered by the rest of the portfolio.

About 79% of Temasek's portfolio comprises liquid or listed assets, down slightly from 82% last year.

In terms of industry sectors, financial services and telecommunications and media continued to account for the bulk of Temasek's portfolio, increasing their combined share from 61% to 64%. These two sectors are good proxies for exposure to the potential presented by transforming economies and a growing middle class.

Meanwhile, Temasek's total investment amount of S$32 billion during the year was split between Asian markets at S$17 billion and non-Asian markets at S$15 billion. In December 2007, Temasek anchored Merrill Lynch in its capital raising exercise with an investment of about $4.9 billion for a 9% stake in the firm. In July 2008, Temasek invested a further $3.4 billion, of which $2.5 billion came from a reset adjustment from the bank.

In line with its strategy to invest in companies with strong comparative advantages and sound leadership, Temasek also invested ú975 million ($2 billion) in Barclays and raised its stake in Standard Chartered Bank to about 19%.

Other investments during the year included telecommunications company Bharti Infratel in India, media company Tata Sky in India, infrastructure company China Railway Construction, and real estate company Binh Chanh Construction and Investment in Vietnam. Temasek also increased its stake in MEG Energy, a Canadian oil sands company, and STATS ChipPac, a semiconductor services provider listed on the Singapore Exchange.

As part of its portfolio rebalancing, Temasek divested its interest in China Cosco Holdings, an integrated shipping company, SNP Corporation, a Singapore-based publishing firm, and Punj Lloyd, an Indian company in the energy and infrastructure sector. It also conducted a trade sale of Tuas Power, one the three power generating companies it plans to fully divest. Tuas Power was sold to China Huaneng Group for S$4.2 billion. The sale of the remaining two generating companies û Senoko Power and PowerSeraya û is expected to be completed by mid-2009.

Besides equities, Temasek has also diversified and taken positions in commodities, fixed income, credit products and distressed assets.