Limited Opportunities And Limiting Strategies

In the unveiling of Budget 2015, Prime Minister Datuk Seri Najib Razak urged state investors, including sovereign wealth and institutional funds, to bring back profits from overseas and invest in high-impact local projects to boost the local economy weighed down by a plunge in global oil prices and the multibillion-dollar scandal involving 1Malaysia Development Bhd (1MDB).

In such a predicament, EPF and KWAP (whose contributors include more than 500 statutory bodies) have limited their overseas exposure and postponed investments abroad to hold up the weak ringgit as well as to invest RM20 billion in local stocks.

“We do not have the luxury of investing more abroad at the moment. We are in the midst of trying to diversify abroad, but we are constrained by the weakness of the ringgit,” says Wan Kamaruzaman.

“So, we have to stick to the domestic market, where the average bond yield is below 4%. Equity performance is low, the dividend yield is about 3.5%, and that does not include capital gains. In the last two years, the equity market has seen a negative performance.”

The limiting situation, he says, makes manoeuvring difficult market conditions to derive returns and looking for opportunities in the local private equity landscape “a struggle”. “It does not help that it has been tough finding opportunities on the local private equity scene. Recently, we bought into a sizeable deal. Unfortunately, the negotiations have fallen through. We are struggling actually. It is not easy at this point of time.” 

This is bound to affect KWAP’s investment return for 2016, he adds. 

Going by the FBM KLCI’s performance, even achieving the target of 5% is a lofty goal, says Wan Kamaruzaman. Last year, KWAP posted a gross investment return of 5.4% — below the 6.15% to 7.07% range for the previous five years. Year to date, the FBM KLCI is down 1.15%, following the decline of 3.9% and 5.66% last year and in 2014 respectively.

“Even if we increase our allocation to private equity, we are not able to increase it significantly as our risk appetite is between moderate and conservative. However, we are looking at revising the allocation to 4% from 2%. If we decide to implement it, we are only looking at 2019 or 2020,” he says. 

“Right now, we have about 9% allocated to alternative investments. Although, we would like to increase it further, the most we would be able to do is increase to 10% of the entire asset allocation or perhaps slightly more.”

Besides allocating 2% to private equity, KWAP has 6% allocated to local and foreign property and 1% to infrastructure. Wan Kamaruzaman doubts that KWAP will be able to increase its private equity allocation beyond 4% as it is restricted by its need to make pension payments to members. 

“This is why it is tough. The domestic equity and bond markets must do well for us. If these markets do not do well, then it is just going to be normal returns,” he says. 

“We are not going to compromise on our risk taking. Our main mandate as a pension fund is to protect our capital. But we still have to try to grow our asset size.” 

The Lack Of ‘right Kind’ Of Private Equity Funds

It is a challenge to find private equity investments that match EPF’s parameters and risk appetite. “There are a lot of opportunities, but we can only invest in those that fit our investment mandate,” says the spokesman for EPF.

For KWAP, which has been facing stiff competition from EPF, Khazanah Nasional Bhd, Ekuiti Nasional Bhd (Ekuinas) and other investors in this space, building its reputation among private equity players is pivotal. The pension fund is hosting this year’s Private Equity Forum in September, primarily to promote private equity as a viable asset class for institutional investors and to engage local private equity players and stakeholders. 

“Both Khazanah and Ekuinas have been aggressive in terms of their direct investments. Even though we would like to have more local exposure, the reality is that there are many other institutional investors seeking similar opportunities,” says Wan Kamaruzaman.

“We are not into certain types of businesses because for us, the size of the ticket is also important. For instance, when we invest in a fund via a global fund structure, the ticket size is close to US$50 million. Some of the small and medium enterprises that are open to private equity are just too small for us to evaluate. The amount of work involved, whether it is RM5 million or RM50 million, is the same. So, we have to be selective.” 

He adds that KWAP’s private equity investments are in sectors like consumer goods, logistics, education, technology and healthcare. “These are the kinds of sectors we want to look at and have more direct exposure as the themes are more relevant to us. Also we prefer strategies that focus on expansion and those that have an established cash flow as they correspond with our risk appetite, rather than private equity funds that emphasise turning companies around.” 

While the low correlation between private equity and stocks and fixed income helps to enhance returns, the lack of the “right kind” of private equity funds and margin compression have had an effect on returns, says Wan Kamaruzaman.

“So far, we have not invested in private equity funds that are too big in their fundraising. We prefer funds that are US$1 billion or less as private equity funds that raise US$5 billion and above make it difficult for us to get good returns. Other challenges include getting the opportunities that meet our risk appetite, investments themes that we like and suitable partners,” he says.

KWAP recently exited a local fund whose performance was disappointing. According to Wan Kamaruzaman, the fund was “supposed to invest overseas but it never took off”.

For the long term, KWAP’s objective is to generate consistent returns. “For our portfolio to be sustainable, our investments cannot mature at the same time. They have to be done progressively so that the returns normalise over the years,” says Wan Kamaruzaman.

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