THE EMPLOYEES PROVIDENT FUND (EPF) expects to see at least 10% of its income come from “alternative assets”, such as real estate and private equity deals, over the next decade to help it continue to deliver good returns on its growing pool of funds, says CEO Datuk Shahril Ridza Ridzuan.

For this to happen, more money will have to be invested outside the retirement savings manager’s conventional staple of government bonds and blue chips, and in relatively riskier assets at home and abroad. Its global assets doubled in the past three years to reach over RM120 billion or 20.97% of total investment assets as at end-2013. The EPF is allowed to invest 23% of its funds outside Malaysia and there is a good chance it will hit this ceiling in 2015, if not this year, say experts.

Without going into the specifics of what the new ceiling for overseas investments should be, Shahril, 44, says it will have to “gradually go up” to give the fund greater flexibility in its investment options.

“When emerging markets were being sold down in the second half of 2013, our investments in developed markets worked well for us … gains there helped provided some buffer,” he says, explaining how income from the EPF’s overseas investments is also hedged to protect against currency fluctuations. “That’s one of the many things we do to give us some level of certainty on the amount of returns we generate.”

As for the suspicion that the EPF supports the local stock market, Shahril — who had joined the pension fund in December 2009 as deputy CEO in charge of the investments division before assuming the CEO’s chair last April — has this to say: “There is no particular level that we think the market should be at … For a [large] fund like us, liquidity becomes an issue … Managing a RM200 billion fund is very different from managing a RM200 million fund … This is why you will often find that we are a buyer when there are many sellers [in the market] and a seller when there are many buyers.”

While it has a long investment horizon, the EPF constantly evaluates its portfolio to carry the best holdings because it pays dividends annually from realised income, he explains.

“This is why if we think there is not much upside left, we will sometimes accept [lower] offers that we think are a decent price for us to exit at because we cannot get that price in the open market,” Shahril says when asked about the rationale behind the EPF’s acceptance of Petronas’ offer for MISC Bhd that some parties saw as low.

He probably would not be surprised to face opposition to the EPF putting more money into alternative assets locally and abroad, but prefers to let the results speak for themselves. When the EPF flagged the possibility of lower dividends for 2013 due to global volatility, some critics deemed that to be a result of the EPF being tapped to support the local equity market as foreigners pulled out from emerging markets, including Malaysia.

Instead, the EPF on Feb 16 announced another record-high dividend payout — 6.35% — which was the highest since the 6.84% announced in 1999. Still, after five straight years of dividend growth, even those in favour of the EPF’s investment diversification wonder if the growth can be sustained as global uncertainties persist.

To be sure, with the EPF’s fund size set to exceed the RM600 billion mark this year, its managers are forced to work harder to deliver at least the targeted minimum annual return of 2% above inflation. Total investments had increased from RM341.01 billion as at end-2008 to RM586.66 billion as at end-2013.

In line with the growth, to pay 1% dividend to its members, the amount the EPF needs has grown by an average 9.12% a year over the past five years from RM3.18 billion in 2008 to RM4.91 billion in 2013. It only needed RM1.68 billion to do the same a decade ago in 2003, when total investments hovered near the RM200 billion mark.

Higher allocation to equities
A closer look at the EPF’s asset allocation over the past five years shows a higher proportion of assets is going into equities while additional investments in fixed income, particularly corporate loans and bonds, has been lower. Investments in equities had grown from 25.7% of total investment assets in 2008 to 43% (RM252.14 billion) in 2013, which was up from RM203.9 billion (38.7% of total investments) in 2012 and RM87.9 billion in 2008, data in the EPF’s annual report shows. By comparison, investments in fixed income (MGS and corporate loans and bonds) had declined to 52.34% in 2013 from 68.25% in 2008, although absolute amounts rose to RM307.1 billion from RM233.4 billion over the period.

It should be noted that equities contributed RM19.5 billion or 55.76% to the EPF’s RM35 billion gross investment income in 2013, up from 34.84% in 2008 when it earned RM6.67 billion. Fixed-income investments contributed 39.19% to total investment income last year compared with 61.17% in 2008.

The EPF’s success in equities, which are seen as higher risk assets than quality fixed-income paper, will likely be closely watched.

As it is, the EPF, ranked the sixth largest pension fund in Asia and the 12th globally by assets under management in 2012 by Tower Watson, is forced to venture abroad so as to not crowd out other local players and to diversify its portfolio.

Despite its participation in several high-profile deals — from the £8 billion, 15-year Battersea Power Station redevelopment project with S P Setia Bhd and Sime Darby Bhd to the RM2.28 billion acquisition of Rubber Research Institute land from the government to be turned into the Kwasa Damansara township — the EPF has invested only RM14.4 billion in real estate and other alternative assets so far. That’s only 2.45% of its RM586.7 billion total investments as at end-2013 (see tables below).

As for the EPF’s real estate portfolio in the UK, Shahril estimates that its value is likely worth 10% to 15% more today based purely on yield compression because the EPF was among the earlier foreign investors in London. “When we started three years ago, we could still get yields of 6%.”

Now, the EPF is scouting around for opportunities in countries like the US and Japan and is likely to enter markets that it does not know very well with strong partners. “In Australia, for instance, we have a strong partner in Goodman Group,” says Shahril.

The EPF is also open to lending its financial muscle for a share of real estate that can provide steady income flow in the future, such as malls or office blocks.

Due to the size of the EPF’s funds, income generation from these projects is likely to remain small relative to its total income base for some time. Nonetheless, the strategy should pay off once some of the larger developments, like Battersea and Kwasa Damansara, where the EPF is targeting a stake in retail and commercial buildings, mature.

Whatever the case, more than 90% of its funds is still invested in fixed-income securities and equities and any increase in the money put into alternative assets, including participation in corporate deals such as the privatisation of PLUS Expressways Bhd, KFC Holdings (M) Bhd and Kian Joo Can Factory Bhd, will be opportunistic. “There is a lot of attention on these projects because of their physical presence … but [even money from land sales] will be small, relatively speaking,” Shahril points out.

Due to its deep pockets, the EPF gets deal proposals by the dozens, but only a handful that fit in with its investment and risk appetite go through. “We’ve been shareholders of Kian Joo for a long time and we think it is a good business that caters for a diversified client base with steady cash flow,” says Shahril, explaining the EPF’s preference for businesses with strong cash-flow generation capability.

According to him, the EPF’s investment panel has a very high threshold for even staple investments like corporate debt paper because of the need to preserve capital while delivering decent growth.

“We hold most of our debt paper to maturity [for yields] … we do not buy anything below investment-grade rating,” he says, adding that even issuers of A-rated paper are evaluated for their cash flow generation capability and gearing position before an investment is made. He declines comment on whether the EPF will take up some of the RM2.4 billion worth of sukuk currently being sold by 1Malaysia Development Bhd (1MDB) to fund the relocation of defence units from the land earmarked for the 196ha Bandar Malaysia development project.

In the long run, once the EPF builds a strong track record, as much as 50% of its funds could be invested outside Malaysia if that’s the best option to deliver growth. For now, Shahril knows a lot of work needs to be done to push the EPF higher among global peers, but he is confident the results will show that the pension fund is on the right track.

As Chua Hak Bin, economist at Bank of America-Merrill Lynch, puts it, some of the domestic capital outflow from Malaysia is a “structural trend with Malaysians or institutions diversifying their holdings”.

At least three parcels of RRI land up for tender this year
At least three parcels of the coveted Rubber Research Institute (RRI) land measuring about 130 acres in total will be up for grabs this year, kick-starting the high-profile, 15-year suburban property project that will contribute to the retirement savings of members of the Employees Provident Fund (EPF).

“Based on the response we’ve seen so far, we think we’ll get a bit more than the price we’re looking for,” says the pension fund’s CEO Datuk Shahril Ridza Ridzuan, who, however, declines to disclose the floor price of the plots.

Tenders will soon be invited for the first parcel of 70 acres, which will house transport infrastructure and facilities, he adds. The other two parcels, one largely for commercial use and the other for residential use, are between 30 acres and 50 acres each.

“We want to control the supply of land into the market,” says Shahril, adding that periodically, smaller plots of land will be put out to tender to allow smaller players to participate.

The EPF’s wholly-owned subsidiary Kwasa Land Sdn Bhd is the master developer of the 2,330-acre RRI land, which will be developed into a township called Kwasa Damansara that will be bigger than Subang Jaya (1,799 acres) and is expected to generate projects worth RM50 billion in gross development value (GDV).

Kwasa Land, which reportedly expects to raise RM11 billion from selling 1,350 acres of the RRI land, will take equity in most of the eight precincts available for development. The equity participation will go towards building future income for the EPF.

As many as 60 developers have reportedly been pre-qualified for the upcoming tender. Events are already in motion.

In late January this year, Kwasa Land sold two parcels in Sungai Buloh — in the vicinity of Kwasa Damansara — to Pink Corner Sdn Bhd and TRC Land Sdn Bhd, who were the highest bidders for the parcels that are said to be at “just a stone’s throw from the main township development separated by Jalan Lapangan Terbang Subang”.

Pink Corner paid RM13.07 million or RM70 psf for a 4.28-acre plot while TRC Land paid RM6.13 million or RM82 psf for a 1.717-acre plot. The parcels were tendered on an “as is, where is” basis based on agricultural titles, according to a statement by Kwasa Land. Both parcels were sold at 13% and 11% above the reserve price respectively. A total of nine bidders participated in the bids for the parcels that were advertised for sale to bumiputeras only in August 2013.

According to Shahril, more small parcels will be made available for tender in the future to allow a broader group of developers to participate in the development.

This story first appeared in The Edge Malaysia Weekly Edition, on February 24 - March 2, 2014.