WHEN the Employees Provident Fund (EPF) declares its annual dividend to members, the one thing that usually resonates is the chorus of grumbles.
For members, dividends of 6% plus over the past few years have set the stage for optimism, whereby expectations of high dividends are to be expected year after year.
Those in the industry, however, know just how hard it is to generate the income needed to pay members of the EPF.
“It is a commendable achievement, given the EPF’s exposure to the local market,” says a fund manager.
“The investment climate over the past few years has not been fantastic.”
For the fund managers, the return of 5.7% for 2016 was a good showing when looking at the local stock market over the past three years. In 2014, the FBM KLCI fell 5.66%. The next year, it dropped 3.90% and last year, the index lost 3%.
For the EPF and other local unit trust companies, the health of the local stock market has been a barometer of returns, especially when the EPF has invested 42% of its RM731bil in equities, much of it in the local stock market.
While there are balanced funds out there that might have performed better, fund managers acknowledge that generating close to 6% returns consistently is a tall order, given the sheer vast amounts of money that go into the EPF every month from its members.
The EPF receives on a monthly basis about RM2bil from its members to be invested for their retirement needs. Over the years, the cumulation of those deposits mean that the size of the funds the EPF has to invest will rise, and dramatically it has, making the job of ensuring high returns harder.
The EPF’s fund size grew to RM731bil at the end of last year from RM685bil at the end of 2015. That’s RM46bil more from 2015 and total members’ savings at the end of last year was RM704bil.
And of its investments, the EPF says a total of 48.58% is in fixed-income instruments and 42.33% in equities. The remaining 4.03% and 5.06% were in real estate and infrastructure, and money market instruments, respectively.
The EPF says it will continue to diversify its investment according to its strategic asset allocation, not only focusing on local equities but also across all other asset classes, both domestically and globally.
“In 2016, 56% of the EPF’s profits were contributed by coupon payments on fixed-income instruments and dividends from listed and unlisted equities,” it says in a reply to StarBizWeek.
The one benefit the EPF has is its position as a long-term investor in Bursa Malaysia. It bought a lot of equities cheap years ago and is sitting on a potential profit in the billions. Analysts say that while the EPF knows it has unbooked profits to be made, it does, however, only recognise profits and payments to dividends once it sells its shareholdings.
Analysts also point out that the need to register a profit has also meant that the EPF is active right throughout the year, trading in shares on Bursa Malaysia to capture gains instead of relying on realising paper-profit at the end of the year.
“The EPF’s trading income across all asset classes are dependent on the market cycle, of which during an upward trend, the AFS (available for sale) reserve will increase and therefore facilitate the EPF to realise more gains. Whereas during market downturns, it provides the EPF with the opportunity to rebalance its portfolio, subsequently improving the AFS reserve in the long run,” the EPF says.
The active participation of the EPF in the market has also meant that some of its shareholdings are closer to market prices than before. It is a big shareholder of banking, and oil and gas stocks and it is this group of equities that caused the fund to take a large investment valuation hit last year.
The decline in the prices of banking stocks, of which carry a 33% weight in the FBM KLCI, dragged down the performance of Bursa Malaysia and caused an impairment of RM8.17bil on its investments, compared with RM3.07bil in 2015.
A writedown can, however, be reversed should these group of stocks post an improvement in their performance this year.
Returns from abroad
One of the reasons why the EPF has been able to pay higher dividends has been its investments in equities and abroad. From an asset allocation in equities that ranged in the teens more than a decade ago, investments in equities was 42% of the fund’s investments at the end of last year.
While equities have given the pension fund the so-called fifth gear in driving returns, it also exposes a potential pitfall that the EPF is all too aware of – the domestic market.
But analysts feel the slump in Bursa Malaysia, which for the first time had three consecutive negative returns for a compounded decline of 12%, will not last.
In fact, it is believed that a better market on Bursa Malaysia will help lift the EPF’s investment income and hence its dividends, assuming all goes well in its investments abroad.
RHB Investment Bank Bhd chief economist Lim Chee Sing feels there are grounds for an earnings rebound on Bursa Malaysia this year, with key commodity prices such as crude palm oil and crude oil higher than they were last year.
He says that earnings, after being flat or contracting in the recent past, have a good chance of coming back this year, and that should drive interest in the stock market and valuations higher.
One of the big drivers of returns has been the performance of investments overseas. With the EPF now close to investing 30% of its money in markets outside Malaysia, the returns from such investments have outpaced that of domestic equities.
In 2014, the return on investment (ROI) from its foreign sources was 10.45% compared with 6.34% from Malaysia. In 2015, it was 12.84% versus 5.74%, and last year it was 9.73% against 6.18%.
Analysts say one reason for the better returns could have come from stronger foreign currencies compared with its ringgit investments, given that the ringgit has weakened against nearly all foreign currencies over the past two years.
“The EPF’s investment asset has been growing at an average 9.31% over the past five years. Even with the closing in on the 30% overseas exposure, the growth in the EPF’s investment asset alone will provide sufficient room for the EPF to allocate more investment overseas,” says the provident fund.
“Therefore, there will be no pressure on the fund’s dividend generation for the coming years due to the EPF not being able to invest more overseas.”
It adds that the current overseas exposure of 29% is also partly due to the drop in domestic equity prices, coupled with an increase in the valuation for foreign equities following the strengthening of major currencies against the ringgit.
One area where there is optimism for future performance will be the EPF’s investment in infrastructure assets. Its ownership of the PLUS Expressways assets in Malaysia, together with Khazanah Nasional Bhd, has been a bonanza that has seen returns beyond the EPF’s wildest dreams.
“Highway assets, which fall under real estate and infrastructure, provide the EPF with a steady stream of income while acting as a natural hedge against inflation. The EPF is always on the lookout for such assets which fit its risk-return profile as a retirement savings fund,” says the EPF.
Such returns, together with its position as a long-term investor, means it has the financial muscle and staying power most other private owners of such assets cannot afford.
Furthermore, its buoyancy over investments in real estate and infrastructure is based on fact. That group registered an ROI of 8.22% last year, only behind its equity investments.
“The EPF’s strategy, moving forward, is to increase its exposure to alternative investments, particularly real estate and infrastructure, and to diversify its investment in the equity and fixed-income portfolio across multiple sectors and regions. The EPF has also been increasing its exposure to overseas investment as a measure to reduce liquidity and concentration risk in the domestic market,” it says.
Dealing with the currency red tape
There were no restrictions or hurdles when the EPF ramped its exposure to foreign investments after the global financial crisis. In fact, the green lane towards investments abroad helped generate the kind of returns it is seeing today.
But with the ringgit battered against the US dollar and a number of currencies in major markets, the attitude it different now when it comes to making big investments abroad. The EPF says it is in constant communication with Bank Negara on how to handle its investments abroad. That’s understandable, as 30% of RM731bil is close to RM220bil worth of investments overseas.
“The EPF has been working closely with Bank Negara in terms of allocating investments overseas without significantly impacting the value of the ringgit. Bank Negara has been accommodative of the EPF’s requirements and needs to continue its overseas investments, especially for the committed investments, and we believe this coordination will continue to work well into the future,” says the EPF.
This understanding will probably extend to allowing the EPF to recycle its money kept abroad to make purchases in future investments. This means that proceeds from the sale of assets overseas will be allowed to be reinvested outside of Malaysia, an avenue that is neutral for the ringgit’s value against foreign currencies.
But the other way of getting the bang for the buck is to raise financing for foreign purchases, using the leverage to buy assets instead of paying upfront for 100% of an asset bought overseas.
The EPF says that raising financing does not mean it is short of cash. With the name it has in the international market, provident funds such as the EPF get preferential lending rates when they seek loans.
“The EPF is not looking for financing to raise funds, as it has a healthy, positive cashflow from the monthly net contribution and investment proceeds available to be invested. However, the EPF through its subsidiaries does carry out refinancing on its overseas assets in order to reduce its foreign currency exposure, which is in line with investment best practices worldwide,” explains the EPF.
“The returned capital will then be invested in better opportunities available in the market.”