The fund's (EPF) conundrum

  • Business
  • Saturday, 01 Mar 2003


HE sits atop a fund that manages RM200 billion and the expectations of 10 million people. With returns to members that are steadily dwindling and in fact for last year, set to become the lowest declared since 1962, the Employees Provident Fund (EPF) chief executive officer Datuk Azlan Zainol does not look as if he is carrying the weight of disappointment on his shoulder. 

Why should he? The fund's investment is governed by guidelines that over the years have changed little to keep up with the times. And where it has, that too has worked out poorly. Fresh, new avenues for investments seem altogether limited while the low interest rate regime and languishing market have all but pushed the fund to a corner. 

So, is his a hot seat? “It's manageable,” Azlan tells BizWeek in an interview. Such an attitude is perhaps just what EPF needs in an environment that has simply become far too challenging for a fund its size. 

Consultancy firm Watson Wyatt (M) Sdn Bhd managing director Danny Quant says this about the Fund's biggest headache: “EPF is a dominant investment institution in the market. That presents it with logistics issue which other investors do not have to face.” (Watson Wyatt is an adviser for EPF on investment-related matters) 

That problem looks set to reach mega proportions. By 2020, EPF will have funds exceeding RM500 billion based on the fund's current growth rate. “I'm just glad I won't be the chief executive officer (CEO) when that happens ... “ quips Azlan.  


A bad ride 

While it may have become fashionable to decry EPF's poor returns and several doubtful investment decisions over the years, it needs to be noted that it has been a bad ride for investors in general.  

Danny Quant

“EPF is a major investor. It has significant holdings in many large companies and consequently will have to deal with liquidity issues in terms of trading of stocks. It cannot be an active trader like the rest. It has different opportunities but they are limited,” says Quant.  

EPF's equity investments make up some 8 per cent of the Kuala Lumpur Stock Exchange's market capitalisation. It has substantial stakes in over 70 companies listed on the exchange. On an active trading day, its transactions make up 10 per cent of total trading volume and 30 per cent on a quiet trading day. Given its sheer size and exposure to the market, the fund is unable to move as fast and as much as it would like to. This is but only one of its limitations. 

For years, EPF has allocated its funds into five asset classes that focus on two key areas – fixed-income instruments (these include Malaysian government securities (MGS), loans and debentures and money market) and equities.  

While the fund has reduced its holdings in MGS substantially over the years and increased its investments in equities, nothing else has much changed.  

Investments in properties have always been rather small but that may change very soon. 

In recent months, it is believed that EPF's investment panels have been suggesting that the fund “increase its position” in property investments. If the plan pulls through, EPF may allocate some 5 per cent of its total assets to this class of investment.  

Although the outlook of the property market may seem somewhat dour at the moment, it is believed that EPF will be looking to invest in buildings that are fully tenanted which fetch a yield of 6-7 per cent over a 10-to-15-year period. Property management, however, requires specialised skills and EPF will need to keep that in mind when taking this big step. 


Low interest 


Government debt papers or MGS used to carry a yield of 7-8 per cent. These days, however, not only are such issues scarce but they have a much lower yield of 3.25 to 3.5 per cent. Not forgetting, some RM30 billion to RM40 billion MGS papers with a yield of 7-8 per cent are set to mature very soon.  

“Once they mature, we need to replace them with more papers but at current low rates, it's going to be very challenging,” says Azlan.  

Accordingly too, interest rates on loans provided to corporates have also come down including the returns EPF earns on its bank deposits. This, coupled with a listless equity market, has turned the last few years into crunch time for the fund. 

Over the years, the fund, owing to the pressure from the general public and spurred by a rising market, has increased its exposure to equities. From an exposure of some 10 per cent seven years ago, today, it has allocated a fourth of its funds to the stock market – the highest ever in its history.  

But should it have done so? Azlan says: “It was okay to go into equity but I admit the timing was bad. In any year where we sell at a loss, we make full provisions. 

"Who would have guessed back then that it was the wrong timing? 

Wisdom of hindsight put aside, the EPF is today grappling with paper losses to the tune of RM10 billion. But that's not the worse it has seen. In the peak of the crisis back in 1998, it was faced with massive paper losses of RM17 billion. 

To deal with this, for the first time beginning with 2002 accounts, sources say, EPF has decided to make general provisioning of RM500 million every year for paper losses.  

This also means that while the returns on investments last year were better than in 2001, the provisioning is likely to drag earnings. 


Alternative investments 

So, why isn't EPF looking for new avenues of investments? 

“What else is there? It's in stocks, bonds and cash,” asks a market observer. “It's hands are tied. The domestic market is too limiting for the EPF.” 

While overseas investments have long beckoned the fund, the timing has never quite worked in its favour.  

Right now, as Azlan himself rightfully puts it, that option is a sure “no, no”.  

Investing overseas would result in a depletion in the country's reserves, something the country cannot afford during uncertain times such as this.  

Moreover, if EPF needed to invest overseas, it would have to go in with at least RM30 billion-RM40 billion. “Anything less than that will not be good enough,” say market observers. 

So far, the fund has invested a relatively meagre sum of RM1 billion via overseas fund managers. That amount, however, is reaping returns of 5-5.5 per cent. 

By comparison, the investments of California Public Employees' Retirement Scheme (CalPERS) with funds totalling US$133 billion or three times the size of EPF, span both domestic and international markets. This largest fund in the US has over 23 per cent invested overseas via fixed income and equities. 

While biding its time to move beyond the shores, it is believed that EPF is currently considering private equity investments. Sources say EPF is planning to allocate some RM300 million to RM400 million to private equity. 


Managing expectations 

Still, EPF's biggest task is managing expectations. Quant wraps this bit up rather well: 

“EPF's biggest concern is that it needs to manage a broad range of expectations ... from young people to old, wealthy to not so wealthy. There are so many parties involved. 

“Any effort to enhance yields means taking more risk. This may lead to EPF compromising on its degree of prudence. But that's not necessarily what the majority of the people want. They may prefer to protect their principal via safe returns.  

“So, EPF will naturally have to go through a relatively conservative approach to err on the side of not offending anybody rather than err to take risk and improve yields.” 

To achieve that balance however is no easy task. Surely, the fund will attest to this.  

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