EPF’s new deal

Shahril at the briefing on EPF annual report 2015.-Art Chen/ The Star. 3 May 2015. Reporter : Loshana, Nadya, Izwan

Go conventional or syariah-compliant, but no switching back

IT is an option with no turning back.

Once a member migrates his or her savings with the Employees Provident Fund (EPF) to the new syariah-compliant investment scheme that will be offered by the country’s biggest retirement fund manager from next year onwards, he or she will not be allowed to switch back to the existing conventional scheme.

So, as EPF chief executive officer Datuk Shahril Ridza Ridzuan (pic) puts it, one has to be very clear on one’s choice of investment scheme.

And there’s no two-way about it: one either chooses to stick to the current conventional scheme, or have one’s entire EPF savings transferred to a programme based on Islamic principles.

“There will be no option to switch back and forth, and the reason for that is two-fold. First, it is in accordance with syariah principles that once the money becomes syariah-compliant, it cannot become conventional again; and the second pertains to administrative and system issues,” Shahril explains.

“So, we want to make sure that our members are very clear in their minds about what they want – whether they want their money to be managed under the existing conventional scheme or the new syariah-compliant option,” he tells StarBizWeek.

The EPF currently manages about RM680bil of investment assets for 14.5 million members, of whom 6.7 million are active members.

It will offer the fully syariah-compliant investment scheme, called Simpanan Syariah, with an initial fund size of RM100bil, in January 2017.

According to earlier reports, the EPF expects between 1.5 million and two million of its members to convert their savings to Simpanan Syariah during the first year of its launch. Allocation will be offered only on a “first-come, first-served” basis due to the limited fund size of the scheme at inception stages.

The EPF is expected to release more information about Simpanan Syariah towards the end of this month.

Strict on non-compliance

Meanwhile, it is goes without saying that under Simpanan Syariah, the compliance requirement will extend to withdrawal for investments in external unit trusts as allowed under the EPF Member’s Investment Scheme, whereby one can withdraw a certain amount of money from one’s Account 1 and invest into EPF-approved unit trusts as long as the Basic Savings in Account 1 is met.

This means members who want to withdraw their EPF savings from Simpanan Syariah for investments in external unit trusts will also be restricted to putting their money only in EPF-approved syariah-compliant schemes that are offered by the private sector.

“Syariah is strict on non-compliance; so, once you opt for the EPF’s syariah-compliant scheme, your money and investments under the scheme will have to go all the way in complying with the faith-based principles unless and until you are totally out of the scheme,” an Islamic finance legal expert, who requested to remain anonymous, explains to StarBizWeek.

“So, even when you withdraw your EPF savings (from Simpanan Syariah) for investments in external unit trusts, your money technically is still under the syariah-compliant scheme and you have to continue to play by the rules,” he says.

Two dividend rates

In line with the implementation of the syariah-compliant investment scheme, going forward, will see the EPF announcing two separate dividend rates – one for the conventional scheme and the other for Simpanan Syariah.

EPF members can expect to see returns from the two schemes differ from one another on a yearly basis, depending on the performance of their investment assets.

In general, the EPF’s syariah-compliant investment scheme will likely give more stable returns, as compared with the more volatile returns from the conventional option.

But the consensus view is that the overall performance of both schemes over the long term will be relatively similar because of the economic and market cycles.

According to Shahril, the variance of the overall returns between the conventional scheme and Simpanan Syariah is expected to be plus/minus 0.5%, or 50 basis points, over a 20 to 30-year investment horizon.

In the short-to-medium-term horizon, however, the relative performance between the two schemes will depend on the prevailing economic and market cycles, with the conventional scheme expected to give better returns in times of high growth and the syariah-compliant scheme to generate more stable returns in down times.

“The simplest way to understand this is to note that the syariah-compliant scheme does not have exposure to conventional banking,” Shahril points out.

“In a bad economic year, when banks tend to underperform tremendously because of the provisioning for bad loans, among others, the syariah-compliant scheme will outperform the conventional scheme.

“Conversely, when things become good again, the banking sector, which is a close proxy to economic growth, will outperform, leading to a better performance by the conventional scheme as compared with the syariah-compliant scheme,” he explains.

No guaranteed returns

While both the conventional and syariah-compliant EPF schemes have the same risk-return objective, that is, a dividend rate of 2% above inflation over a rolling three-year period, what’s missing for the syariah-compliant is the guaranteed-return element.

“Under syariah principles, there are no guarantees. So, the syariah-compliant scheme will no longer have that minimum 2.5% guaranteed dividend that the conventional scheme continues to have,” Shahril says.

The EPF declared a dividend rate of 6.4% for 2015 and 6.75% for 2014.

It is noteworthy that most EPF contributors who choose to migrate their savings to Simpanan Syariah are most likely not driven by the expected returns from the scheme.

As some market observers put it, returns are not the prime objective, but compliance to Islamic principles is.

“Those who switch are most likely driven by religious conviction,” MNRB Holdings Bhd group chief investment officer Ahkter Abdul Manan says.

“If they believe that their returns must be in accordance to their beliefs then they would opt for the syariah-compliant scheme,” he adds.

Even the EPF expects the first batch who switch over to Simpanan Syariah are most likely doing so for reasons of faith and principles, as opposed to the rest, who would most likely prefer to wait and see the scheme’s investment performance over time before making the move.

The EPF expects the syariah-compliant investment scheme, which is offered to cater to the growing demand of certain segment of the Malaysian society, to grow by about RM25bil to RM35bil a year.

The offering, it notes, is in line with the future direction of the EPF, which is to move away from the one-size-fits-all approach towards more tailored products for our society.

“The future for any retirement fund manager is to provide more options for its members,” Shahril says, adding that the EPF will eventually offer schemes with aggressive and defensive investment portfolio to match the different risk-return appetite of its investors.

Investment assets

Both the conventional and syariah-compliant EPF schemes follow the balanced-fund approach, that is, investing in a healthy mix of high-risk equities and low-risk bonds and other asset classes, to generate stable returns and modest capital appreciation for contributors.

As at end-March 2016, equities made up 41.4% of the EPF’s investment portfolio, while fixed-income instruments accounted for 51.7% of the fund’s assets, and real estate and infrastructure represented 3.5% of its total asset size.

At present, close to 100% of EPF’s investments are already compliant with the environmental, social and governance (ESG) standards, which measure the sustainability and ethical impact of an investment in a company or business.

According to Shahril, being ESG-compliant essentially already excludes the gaming, brewery, tobacco and arms-manufacturing sectors from the EPF’s investment.

He notes that all syariah-compliant assets are also ESG-compliant, but not all ESG-compliant assets are syariah-compliant.

At present, 45% of EPF’s existing investments are already syariah-compliant, and these assets alone are worth about RM300bil, Shahril reveals.

“The conventional scheme will still have syariah assets in its portfolio... we’re not excluding conventional EPF savers from syariah assets,” Shahril says.

“In that aspect, we are not creating two funds with the introduction of the syariah-compliant scheme. We are doing this for accounting purposes: the syariah-compliant scheme will derive returns from only the syariah-compliant assets, while returns of the conventional scheme will come from conventional assets plus the a portion of the syariah-compliant assets,” he explains.

Relaxed approach

Critics note one major challenge faced by syariah-compliant money is limited investment avenues, especially in overseas market, where there is also growing competing demand from global funds for such assets.

On that note, Shahril has earlier said the EPF would adopt a “relaxed approach” to syariah complaincy for its overseas investments. He was quoted as saying: “As long as it is inherently syariah-compliant and ethical, with possible good returns, we will look into it.”

In Malaysia, syariah-compliant assets are aplenty, thanks to the adherence of syariah guidelines by most corporations in the country.

“A lot of big cap stocks in Malaysia are syariah-compliant,” Akhter says, pointing to dividend-yielding counters such as Sime Darby Bhd, Amway (M) Holdings Bhd, Nestle (M) Bhd and Ajinomoto (M) Bhd as examples.

“There are also a lot of funds, specialising in syariah, outside Malaysia,” he argues.

Amid the prevailing gloomy economic outlook, the EPF saw its investment income decline 36.2% to RM6.78bil in the first quarter ended March 31, 2016, from RM10.63bil in the corresponding period last year.

Fixed-income instruments was the main driver of the EPF’s first-quarter results, accounting for 55.2% of the fund’s quarterly income, while equities contributed 37.6% of that. The remainder came from other income-generating assets such as real estate and infrastructure and, money-market instruments.