The Asset Update

Malaysia’s EPF seeks consistent long-term return approach

01 Dec 2009 by Chito Santiago

As Malaysia’s national pension fund, the investment objectives of the Employee Provident Fund (EPF) are to safeguard the investments and protect its members’ best interests. It adheres to what is called the strategic asset allocation (SAA) model, which seeks to maximize the expected return for a given level of risk: from the EPF’s perspective, return relates to the dividend that is capable of being declared over time and risk from the EPF’s perspective should relate to uncertainties associated with future dividends.

The SAA model, according to EPF officials, was built to fit the fund’s investment objectives after taking into consideration the restrictions and regulations that the EPF faces. In the process of determining the appropriate SAA for EPF, parameters such as asset assumptions for economic variables, asset class returns and cash flow projections are entered into a ‘dividend calculator’, a customized projection tool that was built specifically for EPF to identify an asset mix that best suits the investment objectives associated with EPF’s risk/return profile.

At the end of the first quarter of 2009, the EPF total fund size stood at 353.93 billion ringgit (US$99.47 billion), up 1.7% from 348.16 billion ringgit in the fourth quarter of 2008. In terms of asset allocation, 145.75 billion ringgit or 41.18% was invested in loans and bonds, up from 40.13% or 137.25 billion ringgit in 2008. The EPF maintains a low risk profile by continuing its policy of having the majority of its loans and bonds in high grade companies with credit ratings of AAA or AA.

Another 97.46 billion ringgit or 27.54% was allocated to Malaysian government securities (MGS), slightly down from the 96.16 billion ringgit or 28.12% a year earlier. Equities accounted for 93.90 billion ringgit or 26.53%, compared with 87.94 billion ringgit or 25.72% in 2008.

Assets allocated to money market instruments amounted to 15.20 billion ringgit or 4.29%, down from 19.03 billion ringgit or 5.56% previously, while those invested in properties totalled 1.62 billion ringgit or 0.46%, basically unchanged from 2008.

In terms of asset allocation since 2007, it is interesting to note that the share of loans and bonds has been inching up, while that of MGS has been waning.

Prudently exploring opportunities

In addition to these mainstream investment instruments, the EPF’s SAA model recommends to allocate 1% of the total investments in alternative investments and the EPF has indeed invested in these instruments, for instance, in private equities and investment funds. Currently, the EPF is considering potential investments in fund-of-funds. Even though they could offer high returns, the fact that only a small portion is allocated for alternative investments correlates to the high risk exposure these kinds of investments entail.

As a retirement fund, the EPF maintains a prudent and low-risk investment approach backed by thorough research and in accordance with investment best practices. To maintain consistent returns in the long run, a higher proportion of investment is allocated in fixed income instruments compared to equity.

Therefore, EPF’s return is mostly affected by interest rate movements. A prolonged low interest rate environment can influence EPF’s annual returns and subsequently magnify the risk of not being able to pay the minimum dividend of 2.5%. The EPF Act 1951 implicitly states that its dividend rate cannot fall below 2.5%.

However, as they tend to be periodic and cyclical, economic crises, slowdowns or recessions offer opportunities and prospects to be explored or capitalized. This is an advantage for a long-term investor such as EPF. When the equity market dropped, for example, it opened up opportunities for EPF to accumulate at low prices stocks with a high dividend yield. Even though such stocks may take a while to appreciate, EPF can be assured of a constant dividend payment.

Disciplined approach

In the second quarter of 2009, EPF posted an audited income of 4.80 billion ringgit, up 46.64% from the 3.27 billion ringgit in the first quarter, mainly on account of the improved performance from its investments in equities. This is a good recovery since the first quarter income figure represented a 10.47% decline from 3.64 billion ringgit in the fourth quarter of 2008, as a result of lower investment returns from both fixed income instruments and equities.

“Despite the instability of the global economy, the EPF has managed to meet expectations and deliver better investment results in the second quarter,” says EPC CEO Tan Sri Azlan Zainol. “This reflects the value of our disciplined approach in managing risks and generating returns for our members. Although higher returns are desirable, we must not lose sight of our priority to provide capital preservation and stability of returns.”

The greatest income contributor was loans and bonds, which accounted for 1.81 billion ringgit, representing a drop of 1.68% compared with 1.81 billion ringgit in the first quarter of 2009. But it was equities which made the largest improvement in earnings when they rose from 239.55 million ringgit in the first quarter to 1.74 billion ringgit in the second quarter − thanks mainly to improving global and domestic markets.

“The second quarter of 2009 has shown signs of recovery on major global equity indices, especially in the countries that EPF invests in,” notes Azlan. “While we cannot say that the worst is over, should this trend continue, or at least be maintained at the current level, we are positive that we can reverse the bulk of the allowances for diminution in value of equity investments that we made last year.”

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Income from MGS increased marginally by 830,000 ringgit to 1.11 billion ringgit, while money market instruments contributed 94.27 million ringgit, a drop of 21.51% from 120.11 million ringgit earned in the first quarter of 2009. Contribution from properties amounted to 20.81 million ringgit, up slightly from 20.63 million ringgit in the previous quarter.

The big challenge

“While there are signs of stabilization in the global markets, it is too early to see how this will affect us for the remainder of the year,” says Azlan. “Bear in mind that things can take a different turn at any time and any decision making must be exercised with care for the best interest of EPF contributors. Nevertheless, as a long-term investor and custodian of a more than 350 billion ringgit retirement fund, we will continue to take proactive measures to enhance the value of our members’ savings in these trying times, while upholding our prudent approach.”

Indeed, as a long-term investor, the EPF does not simply change the SAA in the wake of each market event or economic crisis. But it does make tactical changes <-> or tactical asset allocation − within the SAA range depending on market’s future course of direction. The real challenge of being the biggest market player domestically during this period is market liquidity, which decelerates the realignment of the tactical changes.

In 2008, the EPF declared a dividend rate of 4.50%, down from 5.80% in 2007 (which had been the largest payout in five years). The decline was due to the increase in investment provisioning resulting from the significant decline in global equity prices brought about by the global financial crisis.

Net income in 2008 dropped 15.47% to 14.26 billion ringgit from 16.87 billion ringgit in the previous year after deducting allowances for diminution in value of equities and doubtful debts, dividends for withdrawals, investment and operational expenses, and death and incapacitation benefit payments.

For other Asset Allocation articles, please click here

The Asset Update

Malaysia’s EPF seeks consistent long-term return approach

01 Dec 2009 by Chito Santiago

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