Thursday 28 Mar 2024
By
main news image

This article first appeared in Corporate, The Edge Malaysia Weekly, on May 2 - 8, 2016.

ALREADY the world’s seventh largest retirement fund, the Employees Provident Fund’s (EPF) size is set to reach RM1 trillion by 2021 from around RM700 billion now. While impressive, the growing fund size means a lot more work needs to go into ensuring the EPF’s portfolio asset mix is one that can deliver long-term sustainable returns, especially as the world contends with slower growth and a quarter of its economy has adopted negative interest rates.

EPF CEO Datuk Shahril Ridza Ridzuan admits that the fund’s job will only get tougher. He had already warned of tougher times ahead when releasing its 2015 results in February.

The fact that 48% or RM18.8 billion of the EPF’s RM44.23 billion investment income came from overseas last year despite global assets accounting for only a quarter of its assets was something that stood out. In 2014, global assets contributed 32% to investment income while making up 23% of total assets. In 2013, the income contribution was 23% when about one-fifth of the assets were overseas.

Some market watchers reckon that more money should be invested overseas to get better returns while others feel the EPF would have declared one of its lowest dividend rates in recent years if not for the weakness in the ringgit against foreign currencies in the second half of last year.

Speaking to The Edge recently, Shahril emphasises the importance of portfolio diversification to the EPF and asks that its members not be overly distracted by the annual absolute dividend figure or the performance of any one segment of its portfolio.

“You have to remember that the reason we invest on a global basis is not because we are trying to make money on forex (foreign exchange) but the whole idea is for diversification. The point is to ensure that you’re able to maintain a steady and sustainable dividend through different economic cycles and different points in time in the economic life of a market. So, it is a bit misleading to try to think of any one good year and try to say that a lot of your money came from equities or forex because the point is that over a multi-year cycle, at different points of the cycle, your income is going to come from different things.

“So in 2015, for instance, a lot of the income we had came from foreign equities … The year before that, a lot of it came from domestic equities … You want to have a diversified portfolio that caters for different cycles because different markets will have different points in terms of ups and downs. Last year was one where basically the domestic markets underperformed the global markets and thus the diversification outwards to stabilise dividends,” Shahril explains.

Of the RM18.8 billion income that came from abroad last year, 71% was from equities, 25% from fixed income and 4% from real estate and infrastructure investments. If the ringgit had stayed at 2014 levels last year, income contribution from its overseas assets would have been “between 25% and 35%”.

According to him, “very little” of the income came from real estate disposals because the EPF invests in real estate primarily for the stability and visibility of income streams and looks to gradually increase investments in the real estate and infrastructure space from 4% now to 10% in the coming 5 to 10 years.

“If you look at the numbers that we released for 2015, you would see a jump of 40% to 50% in growth year on year in terms of returns. In terms of the portfolio as a whole, it is still relatively small, but we expect it to be the fastest growing part of our portfolio.

“We’re putting a lot more resources and assets into these areas because of two key reasons. One, the assets we invest in this area are basically inflation hedges, things that are very hard to replace, that have a very high cost of replacement and whose returns tend to be linked to the real rate of inflation. So, for an inflation spread fund like [the EPF], they are an ideal instrument for long-term planning.

“Two, these assets tend to have very high cash flow visibility, so we tend to know the kind of cash flow we will be generating. So we enter these assets less for the capital gains and upside and more for the stability and predictability of income for us. That’s why we like infrastructure, long-term power plants, toll roads, anchor storage, infrastructure and hard assets, properties that have good tenancies … We’ve generally done pretty well so far in this space,” Shahril says.

According to EPF data, the fund had RM20.54 billion or 3% of its assets invested in real estate and infrastructure as at end-2015 and the segment contributed about RM1.7 billion or just under 4% to total gross investment income last year. This is nearly 15 times more than the RM115 million or 0.4% contribution just over half a decade ago in 2011.

Asked if the EPF would soon ask permission to raise its 26% cap on foreign investments, Shahril says the 26% is not a hard ceiling but rather a median target, which means the EPF has flexibility of “a few percentage points” above the cap to cater for price movements. “We’re always in discussion with the Ministry of Finance in terms of the median targets and the asset allocations. As things develop in the markets, we’ll look at whether we want to change these targets.”

Given that equities have contributed 56% to 59% to total investment income since 2013 while only making up 43% to 44% of total assets, will the EPF shift more investments into equities to generate better overall returns? After all, between 2013 and 2015, only 35% to 39% of total investment income came from fixed income, which has 51% to 52% asset allocation.

Despite what looks like attractive gains, there is a fine balance that needs to be struck here.

“If you run a 100% equity portfolio, you’re taking on a lot of price risk into your portfolio and, yes, you could have potentially better returns. If you look at our segmental breakdown, our equity portfolio in 2014 returned double digits of 11% to 12% against fixed income, which only returned 4% plus. So, on a blended basis, you end up with that 6%-plus dividend.

“But in a tough market, like in the first two months of this year, you would see that most people’s equity portfolio would be in negative territory or just breaking even or barely making money, but that fixed income portfolio is still returning 4%-plus. So you do have to balance between how much risk you want to take in terms of your portfolio versus a certain target,” Shahril says.

The EPF’s conservative stance here is not only because it is guarding people’s hard-earned retirement savings but also because it is not a defined benefit fund that needs to hit a certain assumed rate of return to meet pension obligations. (The EPF manages a defined contribution fund where members get back their own contribution plus gains derived from the EPF’s investments.)  

“[If you have to meet a certain pension obligation] then yes, you obviously have to take on a lot more risk to get to that rate of return, especially in this day and age when yields are so much lower. But when you are running it based on an inflation spread, then you can be more conservative in terms of asset allocation and make sure you protect your downside while trying tactically to manage and exceed your inflation target, which is basically what we have done in the last five years, using our portfolio construction [mix] to increase our returns beyond our target of inflation plus 2%. If you look at our performance over the last few years, we managed to get up to inflation plus 4%. So that 200 basis points or 2% is basically excess returns, driven basically by the equity market, good stock (equity) selection and market timing,” Shahril says.

With many Malaysian wage earners struggling to get enough savings for retirement, isn’t there added pressure for the EPF to take on more calculated risks in order to get higher returns for members?

“There’re always many parts of the equation when you talk about retirement savings. The rate of return is one but actually the biggest determining factor is your income level. You can try to crank up the level of return by taking on more and more risks but in the long term, it has very little effect relative to actually gradually increasing the level of income for the people,” Shahril says, emphasising the importance of higher wage levels for more people to have adequate retirement savings.

In his seventh year at the EPF and fourth year as its CEO, Shahril is well aware of the growing public scrutiny of its operations and members’ expectations of dividends. That is why the EPF has voluntarily increased the amount of information it releases over the past decade and is constantly looking at better ways to give a good account of its performance to its members.

“We’re one of the few public funds that actually do a quarterly [results] announcement. Very few public funds do it but we think we should hold ourselves to the same standards that we hold the public listed companies. We make an effort to ensure the people know what we are doing … We don’t have anything to hide … We’re always open to people asking questions about anything we do and in that spirit, I think the EPF is widely acknowledged as one of the best governed in terms of transparency and how we manage our risk issues and compliance … Of course, there are always things we can do better, that’s why we’re always looking at what other funds on a global basis are doing, if there are things there that are appropriate that we can adopt here. We’ll try to do so,” Shahril says.

Indeed, former Public Accounts Committee (PAC) chairman Datuk Nur Jazlan Mohamed had “nothing else to say except ‘well done, Datuk Shahril’” after the committee questioning him for nearly 2½ hours on the fund’s operations on June 11, 2014.

“I think your explanation has been very enlightening and you did not refer to any notes on your table. That means you know the subject matter at your fingertips … We try to korek (dig) here and there but could not shake him. So, congratulations and well done,” he said, according to a record of proceedings of PAC meeting with the EPF on the Parliament website.

Shahril, who had joined the EPF as deputy CEO (investments) in December 2009, succeeded Tan Sri Azlan Zainol as CEO on April 16, 2013. Shahril says his current contract runs through April 2018 and any tenure beyond that really depends on the EPF board.

“We work at the pleasure of the board,” he says, speaking enthusiastically about the days ahead at the EPF.

“This is a very exciting time for the EPF, we’re doing a lot of transformation right now, moving a lot of service online, changing our branches to operate financial advisory centres from just being transactional. We’re introducing the EPF Islamic scheme (EPF-i).

“So it is a period of great change for the EPF. It is a very exciting time and I’m fortunate enough to be here and the board is very supportive of transforming the EPF for the future. We certainly think the EPF is going to be very much a digital platform going into the future in terms of what we do, how we actually reach out and service the employers and members that we have. Certainly in that sense, there is a lot to do the next few years and we’ve got a very good team of people at the EPF and we’re all very excited about the changes that are coming.”

 

Save by subscribing to us for your print and/or digital copy.

P/S: The Edge is also available on Apple's AppStore and Androids' Google Play.

      Print
      Text Size
      Share