Cover Story: KWAP shifts money into equities for higher returns

This article first appeared in The Edge Malaysia Weekly, on June 26, 2017 - July 02, 2017.
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UP to end-May, the returns achieved by Kumpulan Wang Persaraan (Diperbadankan) (KWAP) were about two percentage points more than the FBM KLCI’s, says its CEO Datuk Wan Kamaruzaman Wan Ahmad. However, he adds, the pension fund does not intend to take much profit yet.

Instead, KWAP is putting more money in the equity market as it feels that Bursa Malaysia is still lagging behind other major markets.

“In the first quarter, we didn’t realise as much [profit] because we felt that the market was strong and [will continue to] go up. In fact, we put more money in the equity market,” Wan Kamaruzaman says.

The shift was part of KWAP’s triennial asset allocation review last year. It reduced its fixed-income exposure from 50% to 46% and increased its allocation for alternative investments to 14%. Equity allocation remained at 40%.

Alternative investments comprise real estate (10%), private equity (3%) and infrastructure (1%), KWAP says. The lower fixed-income exposure was in response to the lower interest rate environment, which depressed bond yields and forced KWAP to reinvest at lower yields as its bond portfolio matured.

“Those days, you could get 5% to 6% but in the last few years, it has been very difficult to get even 4%,” says Wan Kamaruzaman, adding that the average yield for KWAP’s fixed income was slightly below 4.5%.

The lower bond yields, coupled with the poor performance of the local stock market, have dragged down KWAP’s performance in recent years. Wan Kamaruzaman says the expected gross return on investment (ROI) for 2016 is 5.35%, which marks the third consecutive year of declining ROI since its last peak of 7.05% in 2013.

“I think, generally, we cannot achieve 7% returns unless we take more risks,” he says, adding that as a pension fund, KWAP is a moderate risk-taker. “The days of 7% would be very difficult (to repeat) because the overall returns out of fixed income are so much lower than before.”

This year, KWAP’s target is around 5.5%, says its CEO. However, the ROI could hit 6%, depending on how the market performs for the rest of the year, he adds. The lower fixed-income exposure also increases KWAP’s flexibility to manoeuvre.

“Tactically, we have room to make adjustments [now]. Let’s say, equity ... we can buy even up to 45% or 47% from 40%; we can increase or reduce by 7%, depending on the (market),” says Wan Kamaruzaman.

The declining investment performance is cause for concern as it is KWAP’s main engine of growth for its asset base. The fund needs to grow so that it can assume part of the government’s civil service pension liability.

While KWAP is supposed to receive the equivalent of 5% of Putrajaya’s annual emolument budget, the contribution stagnated at RM1.5 billion between 2011 and 2014. In 2015, the contribution fell to RM500 million.

For perspective, the federal emolument budget in 2016 was RM70.5 billion, which means the contribution due to KWAP was RM3.53 billion.

In the meantime, the growth in pension liabilities has outstripped that in KWAP’s asset base. The government allocated RM18.94 billion for pensions, retirement allowances and rewards in 2016, and Wan Kamaruzaman expects the amount to hit between RM20 billion and RM21 billion this year.

That is up to a 10.8% annual growth, following 20.6% in 2016 and 11.2% in 2015. By comparison, KWAP’s asset base amounted to RM125 billion as at end-December 2016, according to its CEO — a 5.6% year-on-year growth and the lowest since KWAP was corporatised in 2007. As at end-May, its asset base has grown to RM133 billion, according to Wan Kamaruzaman.

While the average annual growth between 2011 and 2015 was just below 11%, this was supported by a stronger growth in fund size in the earlier years. On an annual basis, the expansion has fallen below 10% in the past three years.

“Obviously, we need to grow faster but there are limitations,” says Wan Kamaruzaman. “Being a young institution (set up in 1991 and corporatised in 2007), it’s very difficult for us to catch up with the pension liabilities but we are doing pretty well in trying to grow the fund size as much as possible.”

According to KWAP’s 2015 annual report, 10.8% of its investment portfolio was parked overseas. While its 2016 financial figures have not been released, its overseas exposure has increased to 11.6%, Wan Kamaruzaman tells The Edge.

While the figure is still short of its aspiration to increase overseas investments to 19% of its portfolio since last year, it is a marginal increase from 10% in 2015. Among other reasons, this has been due to the weakening ringgit since 2015, prompting the government to call for a reduction in overseas investments.

“We have used some innovative ways, like leveraging the properties we have in Australia and other countries to borrow money, charging the properties around 50% to 60% of their value and using the money to reinvest overseas,” says Wan Kamaruzaman. “So (we are) not creating unnecessary impact on the currency.”

Most of the overseas investments are in equities and property. The pension fund’s latest acquisition is a freehold logistics warehouse in Erfurt, Germany, bought in April for €92.23 million. It has a net lettable area of 1.38 million sq ft.

Wan Kamaruzaman says the leveraged yield of the asset is 6.7% (4.6% unleveraged).

In 2015, about 32.5% of KWAP’s overall portfolio was in domestic equities. The pension fund expects the rally on Bursa to continue and its strategy is to ride this upward momentum for now.

When asked if he was worried about a potential shock downswing erasing KWAP’s equity gains so far, Wan Kamaruzaman says the market is liquid enough for a quick response. He adds that as a long-term value investor, KWAP prefers dividend yields to capital gains.

In addition, he thinks it is prudent to maintain a steady performance as opposed to a fluctuating one from realising too much of the capital gains immediately — the stakeholders would be happier with stability than wild swings.

“Here is where we need to manage a bit in terms of expectations. Let’s say our target return is 5% to 5.5%. Even if we outperform, we don’t want to overachieve and put ourselves [in a more difficult position] next year,” he adds.