Onwards And Upwards: Lower EPF, KWAP returns ahead

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This article first appeared in Forum, The Edge Malaysia Weekly, on September 26 - October 2, 2016.


We have had a great run — five straight years of Employees Provident Fund returns in excess of 6%. But with both the EPF’s Datuk Shahril Ridza Ridzuan and KWAP’s (Kumpulan Wang Persaraan [Diperbadankan]) Datuk Wan Kamaruzaman Wan Ahmad warning recently that the current period of low interest rates will hurt returns this year, one senses that the stellar spell will soon come to an end.

Forget that the universe of sub-zero yield debt — mainly European (and Japanese) government bonds as well as a number of highly rated corporate bonds — had expanded to a staggering US$13.4 trillion as at August this year.

Forget that the Bank of Japan last week kept rates at a negative level of -0.1% (and did not rule out further rate cuts).

And forget too that the US Federal Reserve has opted to stand pat on its rate-tightening curve, saying that the weak economic environment does not lend itself to another rate hike to go with its sole (and first in almost a decade) 25-basis-point hike in December.

All that does matter and does not, too, because the resultant influx of global capital into Malaysian government bonds seeking investment-grade returns has compressed yields on Malaysia’s benchmark 10-year bonds to levels not seen since the end of 2013.

At both the EPF and KWAP, which manage the retirement savings of employees and civil servants of a combined estimated assets under management (AUM) of RM805 billion, the current 10-year MGS return on capital of about 3.6% is definitely not going to cut it. Not when at least half of the EPF’s (48.3% in 2Q) and KWAP’s (roughly 57%) returns are derived from fixed-income assets that include private debt and Malaysian government securities (MGS) as well as money market deposits whose returns are directly pegged to market rates.

With the inflows, foreign ownership of Malaysian government and corporate bonds as at July 2016 was at a 22-month high with overseas ownership at almost 50% of total MGS issued, Bank Negara Malaysia’s statistics reveal.

In the equity markets, too, the influx of foreign capital has served Bursa Malaysia well. As at Sept 9, the year-to-date cumulative net foreign inflow into the local stock market was RM2.38 billion.

This is in contrast to a net capital outflow of RM19.5 billion in 2015 and RM6.9 billion in 2014, which not only signifies that some calm has been restored to the local bourse but also the need for global fund managers to find a relatively safe harbour in these low-yield times.

This is all well and good but where do our country’s pension funds go to find avenues to meet the expectations of, say, the EPF’s depositors who have been spoiled by the 6+% returns since 2011?

Just two years ago, depositors were exalted by the 6.75% return, followed by the still-good 6.4% in 2015. What about this year?

The signs looks ominous after two straight quarters of precipitous declines in the EPF’s income. Earlier this month, the retirement fund reported that second-quarter income had dropped 26%, extending the first-quarter slide of 36%.

Farther out, the outlook is not much prettier. Shahril warned of subdued growth with the risks from the upcoming US presidential election and knock-on effects of the UK’s Brexit vote yet to unfold.

And that is even without accounting for the low interest rate environment, which “will pose a challenge as more than half of our investments are in fixed-income instruments”.

At KWAP, one possible avenue lies in private equity, although with a heightened allocation of 4% (from 2%), it is not really going to move the needle. The pension fund may have bought a minuscule 0.05% stake in Uber for US$30 million but whether the ride-sharing service delivers on its gargantuan US$60 billion valuation remains to be seen.

For the EPF, which now has a staggering RM690 billion in AUM compared with KWAP’s RM120 billion, the task is immeasurably harder because of the (much) larger rudder that steers the ocean liner.

So, what is the yield seeker to do?

A search on the internet using the phrase “investing in a low-yield environment” yielded page after page of so-called “advice” of every stripe by so-called investment managers like Pimco, Blackrock, JPMorgan and UBS, exhorting diversification, flexibility, inflation hedging and balancing income objectives.

If these concepts sound exotic and complicated, it is because they are. And it requires fees and costs to invest in them, which also means that they make money in this low-yield environment even if you do not.

Art? Precious metals? Timepieces? Classic cars? Wines? Well, they may be alternatives.

They might — if one buys right — rise in value but they certainly will not yield anything other than the pleasure that accrues from owning them.

All things considered, we have had a great run. Money has been made, fortunes, too, in many cases. But all good things must come to an end. The problem is, judging from the respective decisions of the Fed’s Janet Yellen and the BoJ’s Haruhiko Kuroda, central banks do not quite know how to turn the music off just yet.


Khoo Hsu Chuang is a contributing editor at The Edge Malaysia