EPF’s overseas investment cap should be relaxed
AFTER six years of being rewarded with dividends of more than 6%, the latest returns announced by the Employees Provident Fund (EPF) was not well received by some members of the provident fund.
For the vast majority, the 5.7% dividend that the EPF declared for its performance in 2016 was far better than the rate they would have earned by putting the money in the bank. They have little to complain about considering that the fixed deposit rates offered by banks are less than 4.2%.
To be fair to the provident fund, providing the highest return is not its primary objective. If that was the case, the EPF could have put its money in markets and assets that gave super returns.
It could have placed some money in assets such as currency related instruments that promised fantastic returns but without any certainty of the capital being intact.
High returns come with high risk. That is the cornerstone of investment theory and has been proven time and again.
For instance, there are various currency trading schemes offering high returns. But all of them fizzle out.
Worse is those who invested are left without anything because currency trading have no underlying assets.
We have seen the gold schemes where thousands have lost their savings because the schemes collapsed. In short, investing in high risk schemes is complicated and not meant for the ordinary folk or pension funds where capital preservation is vital.
The EPF does not dabble in currencies. The bulk of its RM730bil of funds under management are with bonds and equities. Its property investments are only 4% of its portfolio while 5% of its funds are in money markets.
Its priority is to ensure contributors get a decent return for their savings and capital is not destroyed. It cannot afford to see great erosion in the value of its investments because members would be unforgiving.
In 2010, one of the world’s largest pension funds – California Public Employees Retirement Fund (Calpers) -- sought more money from its contributors after suffering from a drop in value of its investments. Apart from Calpers, there were other funds in the US and Canada that needed additional contribution because value of its investments eroded significantly from the 2008 Financial Crisis.
The management of the provident fund has made it clear it would not want to get into that kind of situation.
However because the fund size is growing, its options to invest is getting narrow.
The current mantra is to put most money in Malaysia – which is mainly in stocks listed on Bursa Malaysia and government backed bonds.
However when the stock market performs negatively, it impacts the EPF.
Last year, the provident fund set aside RM8.05bil in impairments for its investments. Of the amount, 73% came from its investments in the domestic market while the remainder was from its overseas investments.
The impairments are mainly due to the poor performance of Bursa Malaysia. In fact, last year was the third in a row that Bursa Malaysia has underperformed. Over the last three years, it has cumulatively declined by 12%.
About half of EPF’s domestic impairments came from its holdings of banking stocks. Another 25% was from its holdings in the oil and gas sector while 6% came from the automobiles and parts sector.
The EPF adopts a prudent method in managing its accounts. It only declares dividends from realised income.
All impairments on investments are taken straight to the profit and loss statement while all unrealised gains are booked into the balance sheet. So when impairments are high, dividends become lower.
The question is could the EPF have put less money into the domestic banking stocks?
It would have been difficult for the provident fund because it does not have many options as long as the bulk of its money is channelled to Bursa Malaysia.
If one were confined to putting money only in Bursa Malaysia, the banking sector is the best place to place the funds. It is a proxy to the economy and consumer spending.
Last year was bad for the banking sector where margins continued to be crimped due to the low interest rate regime. However, valuations of banks globally are trending up.
The alternative is for the EPF to put money outside the country. But that comes with other risk such as fluctuations in the currency.
At the moment, up to 30% of the amount allocated to equities are in foreign markets. Is it time to raise the bar?
Based on track record, spreading the funds outside the country have proven to bear results for EPF.
In the last three years, EPF’s investments from foreign equities have been providing the provident fund with above average returns. In 2014 and 2015, EPF was able to declare dividends of more than 6% helped immensely by its overseas investments.
Going forward, the EPF would probably need to look at putting money outside Malaysia to diversify its risk. Most large funds spread their investments all over the globe.
Lets look at Norway’s government fund – Norges Bank Investment Management -which is the world’s largest with funds exceeding US$700bil and seen as among the best managed. Its top seven holdings are all companies outside the country.
The companies are Nestle, Apple, Royal Ducth Shell, Alphabet, Roche Holdings, Novartis and Microsoft.
Large Norwegian companies such as Telenor Asa and Statoil are not among the top seven. The fund has averaged a return of 5.6% between 1998 and 2015 and has proved itself to being able to contribute to Norway’s yearly budget even without the oil and gas resources.
As for EPF, its core holdings for equities are RHB Capital Bhd, Malaysia Building Society Bhd and Malaysian Resources Corp Bhd. Apart from that, it has more than 10% in almost all Malaysian banks.
Over the longer term, the EPF needs to put more money outside the country. But contributors must be prepared for risk.
And more importantly the staff in the provident fund should be well trained and amply rewarded to carry out the task of investing billions and making decent returns without erosion of capital.