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Creating Shariah fund answers call of duty
Property and infrastructure eyed as alternative investments
Gita Dhungana 13 Oct 2014
 
Shahril: Majority of our members are opting for Shariah only mandates  

Generating stable long-term returns is a key responsibility of any pension fund. For Malaysia’s Employees Provident Fund, the task of managing the retirement savings of its 14 million members comes with an added duty of ensuring that funds are invested, as much as possible, in line with its members’ investment principles. It has to strike a balance between the wishes of those who seek higher returns for their savings, no matter where their contributions are invested, and those who prefer to invest their savings only in Shariah-compliant instruments.


EPF is looking into establishing a separate Shariah-based pension fund to manage the savings of members who want their contributions invested in a Shariah-compliant manner. CEO Shahril Ridza Ridzuan says the creation of a separate Shariah fund is in its medium to long-term agenda and this possibility is being explored from various standpoints including operational, accounting, legal and Shariah.


EPF, now the sixth largest retirement fund globally with investment assets of US$181 billion, currently manages both conventional and Shariah investments. But it does not have a provision for its members to choose whether their savings are invested in a Shariah-compliant manner or not. The establishment of a standalone Islamic fund would give EPF members this option.


“Looking at our membership base, we have a high percentage of members interested in Shariah-based funds. When we give our members an option to invest their own money through [EPF Members Investment Scheme], we see that a majority of our members are opting for Shariah only mandates – whether it is just equity or fixed income or mixed mandate,” Shahril says.


“We have been doing some research looking into the possibility of [establishing a separate Islamic fund], but it is still early stages at this point in time. Certainly, we don’t expect something to happen in the very near future. But given what we know of our membership and their demands, we are planning [to do this] in the medium to long-term,” he adds.


EPF manages the retirement savings of private and non-pensionable public sector employees, which at end 2013 totalled 13.95 million. Currently, all their contributions are invested in a number of approved financial instruments which include Malaysian government securities, money market instruments, loans and bonds, equities and real estate.


Expected challenges


The planned fund, if it proceeds, will be one of the few state-backed retirement funds globally that manage their assets in a purely Shariah-compliant manner. In Malaysia, only Lembanga Tabung Haji, which facilitates savings for the pilgrimage to Makkah, manages its funds completely in such a way.


Being one of the firsts will entail challenges. Apart from the operational challenge in the process of converting the organization from a single-fund to a multi-fund structure, the planned Shariah fund will be tested when it executes its asset allocation and risk management strategies.


The lack of supply of a good mix of Shariah-compliant assets that offer diversity could pose a problem from an asset allocation standpoint. “The challenge is not so much on equities – we have enough Shariah-compliant equity assets available, but more on long-term sukuk products,” observes Shahril. “The sukuk market is growing fast, but it is still not as deep as the conventional market. That’s one of the key challenges we need to look at.”


Risk management issues such as concentration limit would be another challenge for the proposed Shariah fund. “The fact that the core conventional financial sector becomes something we cannot invest in from a Shariah perspective means we need to figure out how we can replace that sector in terms of weightage, in terms of concentration risk, in Shariah only mandates.”


With such issues hovering it, the EPF is not seen to set up the planned fund in the near future. “However, if you look at the trends on where the growth is coming from, both in the fixed income as well as everywhere else, the possibility is there that perhaps in a few years’ time, we can start this [fund] and grow from there. Sometimes the supply of the [Shariah-compliant] assets only comes when there is a demand. It is a bit of chicken-and-egg situation: if we start in a reasonable way, in terms of creating enough demand for the products, the supply will start to increase.”


EPF has initiated helping develop such demand and generally expand the capacity of the domestic Islamic asset management industry, by increasingly giving out Shariah-compliant equity and fixed income mandates to external fund managers. “In a way, we have been seeding the market with these mandates to build capacity for some of the asset management firms that we work with. If you look at the mandates we have given out in the last four years, the split between Shariah and conventional mandates has roughly been 50%:50%,” informs Shahril.


Today, about 45% of EPF assets are qualified as Shariah compliant. Often, these meet such requirements by focusing on environmental, social and corporate governance (ESG) investments, making use of the cross-over between the two investment principles, he notes.


“Shariah compliant investments tend to have the same kind of focus on sustainability and governance as ESG. Normally, even on the conventional side, we invest in line with the ESG principal. So our equity portfolios are quite tied with ESG investments, which also tend to qualify as Shariah-compliant,” the EPF head says.

 

Global diversification


Shahril, previously deputy CEO and head of investments at EPF, took over as CEO in April 2013 from Azlan Zainol, who helmed the organization for the previous 12 years.


Since taking office, he has been busy reviewing and revising the fund’s asset allocation strategies. As the size of the pension fund consistently grows, it is inevitable that it further diversifies and expands its investments into new markets and asset classes. For the past 10 years, the EPF’s investment assets have grown at a rate of about 11% annually, reaching 586.7 billion ringgit (US$181.2 billion) at the end of 2013.


One area where the fund has been actively expanding its investments is into the international markets and in real estate sectors.


“Investments in international assets is part of our diversification process to build out asset allocation strategies that match our risk/return profile,” comments Shahril. “Right now, global assets represent roughly 21% of our total asset base but that will grow over time as we expand our investments further with certain assets that are easier for us to accumulate offshore rather than in Malaysia.”


The government has increased the ceiling on EPF’s foreign exposure to 23% of its total investments.


While the fund first ventured into foreign investments in 1996, its overseas investment drive has only began to grow significantly in recent years. Its share of global investments at end-2009 was about 5.96% of total investment assets, compared to 21% end-2013.


To date, EPF has put in US$5.7 billion out of US$7.7 billion investments in equities in the global markets last year. But Shahril points out that the pension fund is increasingly looking at property and infrastructure as alternative investments.


It pumped US$783 million worth of investments in overseas property and infrastructure assets in 2013, while US$936 million were made into the global sukuk and conventional bond mandates through both its internal and external managers.


“We have been focussing a lot on equities portfolio for the last few years. Right now, we are fairly busy building up infrastructure and property portfolios as well. It all depends on what opportunities are in front of us.”

 

Another solid year


EPF’s investments traditionally have been largely dominated by fixed income. But in recent years, its share of investments in high-yielding instruments such as equities and real estate has increased.


In 2013, fixed income investments, which include Malaysian government securities, loans and bonds, and money market instruments, represented 54% of the its total assets; equities accounted 43% of total investments and real estate 3%. By way of comparison, four years ago, fixed income instruments accounted for 72.5% of the total investments, while equity accounted for 27% of the total assets and real estate just 0.42%.


In recent years, the fund’s strategies of increasing exposure into equities and real estate have proved prudent. Last year, due to the low-interest environment, the share from its fixed income investments slid as a percentage of total income, but that decline was compensated by an increase in contribution from equities and real estate.


“The fixed-income yield has been declining over the last few years because of the huge amount of liquidity that has been pumped into the market,” explains Shahril. “Over the last three to four years, as we had to reinvest the money that was maturing, we have found that average yield has come down sharply. Investments that were giving 6%-10% returns are now invested at 4+% yield. That’s why fixed income returns as a proportion of the total returns declined compared to equities. Additionally, equities last year had a very good run, and their share of the income went up for us. That is the reason we diversify. So any given year, depending upon which asset class is performing well, we still have rolling income.”


After delivering an annual return on investment of 6.97% in 2013, or up from 6.87% in 2012 and 6.58% in 2011, EPF declared a dividend rate of 6.35%, exceeding its statutory commitment of 2.5%, and representing a record pay-out in ringgit terms of 31.20 billion ringgit.

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