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EPF has to diversify abroad to obtain better returns

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Louise Jardin
Louise Jardin has been in Asia for twelve years and written for a series of journals and newspapers including the Japan Times in Tokyo, CFO Asia and a number of financial journals across Asia. She now lives in Hong Kong.

WHEN news broke that the Employees Provident Fund (EPF) was partnering Khazanah Nasional Bhd in the RM23bil takeover of PLUS Expressways Bhd, the deal was more of a surprise on the political front than the economics of the deal. From the politics angle, the proposed takeover of the assets and liabilities of PLUS is a means to keep a lid on the high toll rates drivers pay for traversing the highways. The purchase would also ensure EPF contributors enjoy a higher rate of return in the future. EPF deputy chief executive officer (investment) Shahril Ridza Ridzuan said in a statement following the announcement of the joint takeover offer that the deal offered EPF an opportunity to acquire a “mature, cashflow-generating asset with an attractive risk-return profile, which would provide stable returns for our contributors’ retirement savings.” That financial reasoning of the deal is simple. Much of the money PLUS stands to make is yet to be realised and as a concession matures, so will its cashflow generation capability. What impact a tweaking on the concession agreement will have on the future income of PLUS is yet to be determined, but analysts expect the final return EPF would get from its acquisition would be much better than what it would otherwise get for its cash in an alternative investment like Malaysian Government securities. “EPF has a certain return target to meet and that’s in line with beating inflation,” said MIDF Amanah Asset Management Bhd CEO and chief investment officer Scott Lim. “If fixed income is not offering good yields, then it has to move elsewhere.” The move into PLUS is also consistent with the direction the EPF has taken in recent years in its investment decisions where it has assumed control of companies on Bursa Malaysia. Getting involved directly in business was a means of seeking higher returns but the EPF has learnt a bitter lesson if the right conditions and personnel are not there to carry out its plans. It got its fingers burnt from its ownership of Malaysia Building Society Bhd (MBSB), where it incurred massive losses caused by the Asian financial crisis. That forced the EPF to swallow a huge loss in that investment and forced the fund to oversee a thorough restructuring of the building society which saw MBSB return to the black. “It means it (EPF) must have a pool of outside expertise if internally it cannot run it better,” said Philip Capital Management Sdn Bhd chief investment officer Ang Kok Heng on the move by the EPF to take control of companies. Its desire to control companies did not stop there as EPF won control of RHB Capital Bhd in 2007 after a fight with EON Capital Bhd and Kuwait Finance House Bhd and it later assumed control of Malaysian Resources Corp Bhd (MRCB). The EPF, through MRCB, is also undertaking a mixed development of the massive tract of land in Sungai Buloh where it will be spending RM10bil until 2025. The EPF had two main advantages in the ownership of companies, said Ang. Time was the first advantage as being a pension fund it could hold onto its investments for a long time, he said. “The second is its size. The EPF can diversify its investments and in the long-term have higher and better returns if it holds onto its investments long enough,’’ he said. The takeover of RHB Capital and MRCB has seen the performance of those companies improve under the tutelage of EPF. Analysts said the diversification of EPF’s asset allocation strategy into private equity deals or even investing abroad is a way of squeezing higher returns from a pool of funds under management that has grown far too large for an economy like Malaysia. There are concerns over the size of the EPF in the local stock market where on average, it is the largest trader on Bursa Malaysia on a daily basis. “There are still opportunities in Malaysia but our stock market is not growing fast enough for it. The EPF has already 32% of its investments in equities,” said Ang. In 2005, EPF had total investments of RM259bil. As at the end of the second quarter this year, its total investments have soared to RM406.6bil. Most of its latest investments are in loans and bonds which totalled RM151.6bil or 37.3% of total assets. That is followed by equities at RM130.9bil or 32.2% of total assets, Malaysian Government bonds (RM94.8bil; 23.3%), money market instruments (RM27.6bil; 6.8%) and property (RM1.6bil; 0.4%). Returns-wise, in terms of size, equities was the largest contributor to investment income with RM2.7bil of the RM5.9bil the EPF earned during the quarter. Returns from equity investments were up 56.6% from the same period a year ago. Next in terms of income contribution was loans and corporate bonds at RM1.9bil followed by returns from government securities at RM1.1bil. Returns from the money market, thanks to rising interest rates, gave the fund RM183mil profit for the quarter while gains from properties was RM22.8mil. The large size of its funds, of which most is now dedicated for Malaysia, has also led to sub-par dividend returns for contributors this decade where the average dividend rate has been above what risk-free fixed deposits offer but from a historical perspective, they are below the norm. Last year’s dividend of 5.65% was the second highest this decade but in terms of perspective, the last time returns were that low before this decade was in the 1965-1967 period when the dividend rate was 5.5%. The best years the EPF had in terms of dividend returns were between 1980 and 1994 where the annual dividend was 8% to 8.5%. Analysts have maintained that for the EPF to seek better returns in the future without exerting a tremendous influence on the domestic markets means that the EPF would have to diversify abroad and in Budget 2011, that was done when the Government announced that the EPF would be able to invest 20% of its money overseas. Furthermore, the EPF is said to be getting more involved in private equity and property ownership by buying buildings abroad where rental yields are higher. Additional money being invested overseas will expose EPF to the vigours of such investments. Private funds that have managed to do so said returns are also about the timing as volatility in the large emerging markets or even developed markets is larger than what is experienced at home. Also, the EPF will be exposed to currency risk, which could be a double-edged sword for investors when investments sour. “I believe the EPF would have done its homework when going into property or private equity deals,” said Lim. “In the pursuit of returns, there is always going to be higher risks.’’

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