EPF Diversification at the Crossroads
Datuk Shahril Ridza Ridzuan, CEO of Employees Provident Fund (EPF)
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EPF has made great strides in diversifying into foreign assets as well as upping its equity allocation. But retirement adequacy is still a huge problem. EPF is now having dialogues with the government for some kind of national income policy. There also appears to be an existential crisis of how to deal with the sharply devalued ringgit over the last few decades and how to move away from the mindset that home is best as far as investments are concerned.
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Statutory bodies like Lembaga Tabung Angkatan Tentera, Tabung Haji, MARA; now they've all received very negative press regarding they way they conducted businesses. EPF however, seems to be spared that. Care to share with us why?
"Well I think, as you know, the EPF takes a very high view on integrity, on governance and transparency as well. So I think if you look at what we're trying to do over the last four or five years especially, is to increase the amount of transparency of our proceedings, of what we do, and also in terms of our governance standards, to make sure the people understand that the EPF operates at the highest level of governance."
"So it goes beyond just the structure of EPF. We have two boards. The board of directors that looks after the social security issues, and an investment panel that looks at independently at investment decisions. But all the way down to our transparency, if you look at what we do at a quarterly basis, we are one of the very few funds that actually announces quarterly results. We believe that is important because we hold public listed companies to a particular standard, and we want to make sure that we try to adhere as close to that as well."
"If you look at our annual report, it goes into a lot of detail and not only about our investments, our accounts, but even down to our operations and what we do for our members. And I think it's important to remember as well, it's not just about managing money, it is also about managing the experience of our 14 million members and our 600,000 employers to make sure that whenever they come to an EPF branch, when they deal with the EPF staff, they get the highest level of service as well. So I think that the nett experience from the customer point of view, which is an affirmation that our belief in the integrity of the whole process. This basically goes along with assuring people that we are the kind of organization that they can rely on. Not just to manage the money, but to deliver the best service possible to members."
You were appointed to head EPF back in April 2013, what sort of succession plan does EPF have?
"Well, succession planning is extremely critical for any organization. For us especially at the EPF, we have been doing a lot of work over the last few years. Introducing new trainings and new programs to make sure that we have an internal pools of successors ready for a lot of key positions. I know, we have had discussions with our management, we're trying to focus on an 80-20 principle where at least 80% of all positions that come available for promotions or hiring are filled from internal resources. And only about 20% are from external resources."
"And to do that we have invested a lot in terms of making sure that we have our people ready at all times. Sitting underneath me i have three deputy CEOs who are all very capable people and certainly I think at a pinch any one of them could fill in for me if I were to not be in the organization any more. And seeing things as far as EPF is concerned, our board takes a very serious look at it, and is a very augmented program to ensure that we have key people available for all key positions."
"And what we do today is that we already know in advance, who's retiring, who's leaving the company, and we try to make sure that 3 months ahead of that departure, we have someone in place already to take over and to shadow that position for at least a few months before they step in to take over."
"Well, they've renewed my contract in 2015 for another three years so certainly I think if all goes well, I'll be here for all those three years until 2018. Well I think it is quite an important period for us as well as we are doing a lot of transformation during this period as well as the introduction of our Shariah savings programme."
"Well certainly if all goes well, I will be here for another 2 years until 2018. And I think it's an important period for us as well. We're doing a lot of transmission during this period including introduction of our syariah savings programme as well as you could see during the presentation of our annual report of changes of how we deliver our services. We're focusing on a lot more internet delivery and pushing online. And that's a very big part of my plan for the EPF for 2017, 2018. And b basically to make EPF and online organisation as far as possible. "
"So certainly until 2018 I will be there. And anything beyond that is anybody's guess."
The long term performance of the Ringgit against the USD has fallen sharply. How does it affect concerns over requirement adequacy of Malaysians?
"If you look at retirement adequacy, it's actually a multifaceted problem. It's not just about the investment rate of return that we generate on investments. But it goes down to even the wage levels, the income levels. And that's where EPF has been a big supporter of a lot of the government policies that revolve around minimum wage for instance, or increasing the age of retirement. Because those are actually two more important factors in terms of determining retirement savings adequacy rather than just focusing on the rate of return. The rate of return at the end of the day, is governed by the market. And we can try to outperform the market, which we have done for the past few years. But honestly speaking, you're better off, from a national policy point of view, focusing on minimum wage and retirement age as two of the key factors in determining retirement savings adequacy. And that's why we've been working very closely with the government to promote the idea of social security protection task force. And that will be formulated hopefully in the very near future. It actually looks at the long term economic planning around these issues."
"It's very important because we've been for a very long while blessed with a very strong demographic profile. We have a lot of young people coming in. The country has derived that demographic dividend for many decades. But that's changing by 2030, we'll be an ageing nation. It won't be long before we become an aged nation like a lot of Asian countries like Japan, which is now struggling with that problem. No matter what you do on government policy, it's very hard to get around the fact that you have an ageing population, and to a certain extent a shrinking population. Korea is facing the same problem as well, we need to focus and think about the long-term issues and refocus that part of it. "
Is EPF going to make a greater push for outward investments ?
"If you look at portfolio construction, the reason why we have a fairly significant portion of assets invested on a global basis is for a few reasons.
1) Given the size of the EPF we have to be very careful that we don't distort the local market. I think that's quite important, and the fact that we know we are constantly investing every single year is a very key factor in why we are pushing a lot more overseas. In 2009 when I first joined the EPF, our global assets stood at about 6% and you know very consciously we decided that we needed to increase that tremendously to provide that diversification to our income and to protect ourselves against any downturns in the domestic market vis-a-vis the rest of the global markets.
But why not expose Malaysians to more global innovation and growth?
"We do, but you have to remember as well, that the bulk of EPF members will retire in Malaysia. So if you look at basically, that matching principle between what the assets are, and what the future liabilities are."
"For the bulk of Malaysians who are retiring in Malaysia, the focus is really on making sure that from a ringgit return point of view, you are comfortably exceeding the ringgit rate of inflation."
"And the rate of inflation in Malaysia, of course, there's an internal component and an external component. So if you look at the way we actually structure the asset, the global assets that we invest, to a certain extent, mimics and helps to protect against the imported inflation. But the bulk of the inflation that you see is still very much going to be internally-generated inflation."
"And that's why if you look overseas today, despite the fact that commodity prices globally have plunged and aggregate demand globally is tapering off, but domestic CPI inflation in Malaysia is still comfortably at the 2% range. Whereas if you look at global developed economies, their inflation is running at below 1% today."
[JULIAN] Lifestyle inflation is pretty high though.
"Lifestyle inflation is imported. But like I said, when you look at total inflation, a lot of it is domestic pressure. And that's due to either domestic inefficiencies in the channels that we have in Malaysia, that push prices up and keep prices up. Or domestically-linked inflation. "
"And that's why the imported inflation component is basically fairly small in Malaysia. And that's why in terms of the impact on CPI, like I said, CPI in Malaysia still runs at 2%. CPI in a lot of developed countries, where you have less of those domestic inefficiencies, are all now running below 1%."
"So ultimately when you do a portfolio construction, you can't have a portfolio that is so heavily weighted overseas as well. Because then you introduce risks of having a mismatch with your future liabilities for your future retirees, who by and large will retire in Malaysia with their retirement money."
"So yes, there is a certain amount of imported inflation, but you also have to remember, when we talk about inflation -- this is a conversation I always have with my people here -- inflation is a very personal thing."
"When you talk about CPI, it's basically a basket of goods, which tries to reflect the average spend in malaysia. Inflation is a very personal thing. What I spend my money on, what you spend your money on, are completely different. So our personal rates of inflation are completely different as well. It's going to be very hard for us sitting in KL, to judge and say that this is the right asset mix or right rate of return, than say someone in Sabah or Sarawak."
"And similarly as well, when we make investment decisions, we have to look at the average portfolio for everybody in Malaysia. What we do provide for our members, especially for those who are more financially literate or astute, is the ability to manage a portion of their money for themselves. Because you know we do allow people to essentially transfer money from EPF's system into unit trust."
"So if you feel that you want to have more of an equity mix in your portfolio, it's perfectly fine to do so. But we do restrict however it is to make sure that you must have at least a basic savings in the EPF because that is your base retirement sum. Anything above that, you're free to essentially manage on your own."
"And a lot of people have taken advantage of that, with varying results. As you always say, people's estimation of their financial literacy tends to be on the overly optimistic side."
"But we do tend to tell people, you can do so, it's your right to do so, but please be very careful to make sure that what you're investing in matches your own investment horizons."
There is a growing interest to diversify into real estate. How are these plans going forward and what targets have you set for yourselves?
"It's about 4 % today for real estate, infrastructure, and private equity right now. We intend to drive that towards about the 10 % mark. Which is more in line with what global funds are doing in terms of their portfolio construction and in line with what we think should be the right mix for us. It takes longer as you can imagine, with this kind of assets, because unlike market instruments like bonds or equities where you can just trade in the market, there's price market mechanisms and there's liquidity with private market assets, essentially they need to do a lot of due diligence to ensure that the assets both fit into your portfolio which is your own construction, and it takes a lot of time. And what we have found over the last few years as we've been doing it, is that we are better off concentrating on larger ticket sized items, because the amount of work required to do say a RM 300 million deal is about the same as doing a RM 50 million deal. So in terms of the amount of resources we have internally to actually do this due diligence and to run the process, it makes more sense for us to actually focus a bit more on those items which can move the needle for us. And that's why you see us doing more larger sized items rather than the smaller sized items."
EPF has embarked on the MRCB Bukit Jalil development. How much of your experience in MRCB has to do with this?
"Well, we are in constant communication with all the developers, in terms of basically all the land banks that they have. So that's why if you notice we've done a lot of deals in the past with people like YTL, SP Setia, we're doing BBCC with Eco World today, and of course with KWASA land, we're doing a multiple number of developers who are working with us there. So we're always looking at making sure that the right asset is in place for us to invest in. The Bukit Jalil site, obviously you know, because EPF is a major shareholder of MRCB, it has to go through shareholders' of approval before the deal can go ahead. But we like that site because it gives us an opportunity to invest in an area that's already well proven. It's a fairly sizeable piece so it makes sense for us to do it, in terms of deployment of investment capital and it's a long term asset. Obviously for MRCB it makes sense for them because they don't have to stretch their balance sheet and they can focus on being a developer as opposed to investing in the asset itself. A lot of developers are now moving down that channel or along that path because as land prices increase, it gets more and more expensive for developers to actually outright buy land. So you see, a lot more deals come into place today where financial investors coming in, working with developers, and it's very similar to what you see in Australia, the UK, or most developed countries where developers have to bring in financial investors, otherwise they can't carry the cost or the risk of one asset on their own."
But has this morphed EPF into more of a developer's role. Does this change the risk profile compared to the investing portfolio?
"Well we're not developers, just to correct you there. What we do basically in these cases, we come in as financial investors, so we own a percentage of the development. But the development is all handled by our development partners. So for instance, BBCC - Eco World is doing it for us. We own a slice of the investment there but Eco World and UDA basically run the project. So they bring in the marketing, they bring in construction expertise and everything else that goes with it. EPF is not setup to run development project or to run construction project."
So what are the risks and returns compared to portfolio investment? For example EPF's fairly safe investment returns of 5-6% over the last 10 years or so. What are the returns for these projects?
"Well generally when we look at these kinds of investments, we have an internal target return that we try to analyse and make sure that these projects can deliver for us. So typically I think and you would've seen this when we invested in PLUS for instance, for this kind of assets where you take on a certain amount of market risk, in the sense of marketing risk, we'd like to see internal IRRs in the double digits. So depending on the exact type of asset or the location of the asset or whatever it is, it can range anywhere from between 10 to 15 percent IRR targets that we're looking at."
"We don't do angel, we don't do venture, we don't even do first fundings which you know other funds are better equipped than us to do stuff like that. We can't take that kind of risk with retirement money, and I think people understand."
Why stop at 10% of the portfolio?
"Because you have to look at the flipside, which is risk right now. Obviously, we've also been offered lots of projects, which promise you an IRR of plus 20% north but nobody gives you that kind of return without the associated level of risk that you take on for those kinds of projects."
"So we always look at it from a risk spread point of view. We always look at the asset. We try to think as to whether it's at a risk level that we are comfortable with because there are some projects which no matter what returns you promise us, we will never touch. The risks are just too high in terms of how we feel in things that could go wrong. That's why you don't see us do venture capital for instance, right. Very high promised returns but a lot of risk failures involved. So we don't do venture capital."
"We do private equity. But we do private equity which is in the later stage of private equity. So we do buyouts, we do for instance late stage expansion private equity. We don't do angel, we don't do venture, we don't even do first fundings which you know other funds are better equipped than us to do stuff like that. Khazanah does a very good job in that space. But they are set up to do that kind of stuff, we're not. We can't take that kind of risk with retirement money, and I think people understand."
"If you look at capital markets, there's a space for everybody. For retirement funds like ourselves, it's very much in that end stage phase where basically earnings have become more stabilised. We do a lot of toll highways, a lot of power plants, we do a lot of yielding assets, yield buildings. We mix that with some developments where we feel the risks are bearable and where the risk return tradeoff basically is favourable for us"
"A classic example was Battersea. Remember Battersea? Basically a large investment but in the big scale of things for the EPF, very manageable. It's actually a very small part of our total global portfolio of properties. But because it's Battersea, generates a huge number of news. Completely disproportionate to our actual investment in it but from a risk point of view, we are perfectly happy with it because ourselves, SP and Simon looked at the deal, and we're buying in at essentially distressed prices from a distressed seller."
"So the mantra we try to do basically is that we try to get good assets from distressed situations where the people holding on to it can't hold on any longer or is an asset we can take over through some restructuring of the balance sheet and the financial side, we can really make it work for us."
"Plus was a classic example. You had a situation when it was in an untenable position at the time we were coming in but once we came in we restructured the finances of Plus, and now it is a great asset for us, yielding decent returns, decent dividends and providing good returns for our contributors."
"But what we did was to tell people: it's their choice. We can't dictate the personal individual circumstances for every single member."
You once advised EPF members to maintain the 11% deduction of their salary despite the government allowing a lower 8%. How many members have taken up this option?
"Yeah, at that time, but basically what we did to advise people was to consider very carefully what they wanted to do, choosing between the 8% and the 11% contribution rates. But what we did was to tell people: it's their choice. Again, just like inflation rates, it's a personal choice. We can't dictate the personal individual circumstances for every single member. What we have seen to date is roughly 50% of active members have chosen to stick to 11% which is more or less in line with previous campaigns of this nature where half the people will opt for a reduction and half will stick on with the original rate of contribution."
The number of members withdrawing their savings almost as soon as they turn 55 is on the increase. Is this a worrying trend ?
"Well it's worrying to the extent that we are concerned about people's long-term retirement adequacy. But we understand, especially in an era where people feel the need to pay for instances education for their children. And increase in education withdrawals over time. We can understand why people feel the need to draw down on their funds."
"So the extent that they are drawing down for items which we allow, I think it's understandable and it's ok. We only allow for housing withdrawals... so people are building assets in a different way - you have a house asset now. People are building for education withdrawal which again is an investment in the future. Hopefully the kids pay-back." "
"And of course we allow for medical because you have to allow for medical otherwise there is no point in having a retirement which you can't physically enjoy. So that's fine but we always make sure that they maintain their Account 1 with us, and we try to make sure that they build up towards the retirement savings amount that we always advise them to do - basic savings."
"I think unlike Singapore, we have to take a view that people need to be responsible for their own financial affairs. I don't think that big brother in any state works for Malaysia. But what we try to do is to work on the financial literacy part of it. One of our big focuses is to expand our retirement advisory service to more branches."
There have been cases of members making early withdrawals to buy houses, but sell it later. That money doesn't actually go back into EPF. Singapore's CPF meanwhile requires money from the sale of homes to be put back in. Is EPF thinking of doing something similar?
"It's a bit tricky. Singapore can do it because it is linked intrinsically to HDB. So a lot of the CPF housing withdrawals , maybe all of the them are for HDB purchases. So it is much easier for them to track the system."
"And Singapore government being the big brother that it is, is able to essentially make sure whatever you do on that side and the money can be tracked and brought back to the CPF. Fairly easy for them."
"Malaysia, because of the way the Malaysian property market works, it is extremely difficult to do so and we don't have the power or the right to manage these kind of affairs. So if people are going to withdraw their money to buy a house, good luck to them. If they make money on it, all the better."
"So we would hope basically that any gains that they make on selling their property are invested properly or basically used for them to build an asset for themselves."
"But I think unlike Singapore, we have to take a view that people need to be responsible for their own financial affairs. I don't think that big brother in any state works for Malaysia. But what we try to do is to work on the financial literacy part of it. One of our big focuses is to expand our retirement advisory service to more branches."
"We already have eight branches running and we are going to open up maybe another 10 or 11 branches this year. And the whole idea is basically the availability of any our members to come to our branch and get free advice. It's non-product specific. So we are not trying to sell you products unlike banks or insurance companies. But we'll help you in your retirement planning for you to understand what your expenses, and assets are and how to make them work for you for the future. And that's been a big success."
"Last year alone, we had about 10,000 people utilising the service and I think most people really appreciated being able to get someone to explain to them financial matters."
And what are the qualifications of these advisors?
"Well as as part of the transformation of EPF, we are moving towards becoming a service and advisory organisation from a transactional organisation. So we've been training a lot of people to become registered financial planners (RFPs) to get the proper professional certification. This year alone I'm sending a hundred people for those courses and to be professionally certified."
"So the whole idea is that over time, the EPF as a whole will be populated by people who are either professionally qualified as financial planners, CFA's, accountants, you know, and that's part of the upskilling we are doing in EPF."
In the future unit trust transfers will all be done online through our system so our members no longer have to go through agents to make their unit trust purchases.
There are also innovative products out there like reverse mortgages to deal with people selling their properties, there are also robo advisers and extremely low cost ETFs. How is EPF responding to these changes ?
"You're always going to see a lot of innovation especially in this day and age when technology is all-pervasive. You're going to see a lot more coming in. That's why EPF is also making a lot of changes in terms of how we deliver our services, investments in technology in everything that we do."
"If you look at reverse mortgages, it was something we actually looked at three or four years ago. There were some proposals being kicked around at that point in time. We didn't discuss with the bank because it's really more of a commercial product. Its really not a product that EPF can offer because if you look at other markets, it's a product that's offered by the banking industry as part of their overall financial planning suite for their customers."
"It really hasn't taken off in Malaysia. One, cultural issues. Basically people can't get their heads around the idea - the house I am staying in has already been pre-sold and effectively sold off to someone else. People in Malaysia like the idea that they can leave their property to their family. I think you'll find in Asian countries as whole reverse mortgages have not found much ground for adoption."
"The other things we are doing; I mean you look at advisory work - we will be expanding to provide automated advisory through our online systems. We are doing a lot to work with the banks to fully integrate our systems with them."
"One of the things we are moving to like unit trusts is part of our roadmap. In the future unit trust transfers will all be done online through our system so our members no longer have to go through agents to make their unit trust purchases. And we already have a system in place where where people can just go through our system to track the performance of all the unit trusts we offer under our scheme to avoid a lot of the misunderstanding that happens."
But unit trusts are expensive. Can EPF use its clout to reduce costs?
"Precisely, today if you go through an agent and buy unit trust through their system, you are paying, if I'm not mistaken 3% commissions upfront. We plan to move everything online within the next couple of years and by eliminating that huge commission, we are giving that benefit back to our members. So we will be working with the industry to bring down these commission rates."
"Its very similar to broking. In the past it used to be a remisier's 1 or 1.5%. Today with online broking you're paying maybe 20-25 bps."
"So similarly we foresee that by moving everything online, we can bring a huge amount of savings to our members. From 3% to maybe 0.5%. After all why do you have to pay so much for moving your money to unit trusts."
So with this option for EPF members to invest in unit trusts. As management fees are quite expensive and I understand that the EPF gets a discount from the external fund managers (EFM). Can you do the same for members who want to go the unit trust route?
"I think part of the problem with unit trusts is that it's is part of a pool. So it will be hard for unit trust managers to have differentiated management fees depending on who you are. Because you're part of the same trustee pool of management assets so I can understand why unit trust companies are a bit reluctant to try and differentiate in terms of the management fee costs."
"You talk about EFMs. We negotiate their mandates with us separately. We get very good rates because of the bulk we bring. This is probably a good point to highlight that the EPF is a very efficient manager in terms of our total cost of operations is only 27 bps. And within that 27 bps investment costs is only about 9bps."
I understand that EFMs adds 75bps returns to the ROI. Is that net of costs?
"Yes its net of costs but it's slightly misleading because you have to understand the EFMs that we operate with, they are focused on areas where naturally you'd expect higher returns. They are mostly in equities, in private equity for instance, infrastructure assets, very limited in terms of the fixed income space. The fixed income space we tend to a lot of that ourselves. Because of that there is a natural bias towards generating a higher ROI because they are operating in asset spaces where we expect them to generate a higher ROI. So it's not directly a like-to-like comparison."
There is a difference of ROI of 7.5% and dividends of 6 plus percent, what accounts for this difference?"
"One is cost of operations, the 27 bps that goes to the cost of operations. The other is in terms of provisioning. We're extremely conservative in terms of our accounting policy. So what we do is that unrealised losses, we take them to the P&L. So last year alone, because of the fall in markets, we took in roughly three plus billion of unrealised losses on the balance sheet which we moved to the P&L that reduced ROI to the dividend that we have today."
"So we're extremely conservative. We take unrealised loss into P&L, unrealised gains always sit on the balance sheet until they are realised. That's why when you look at the balance sheet of the EPF, it's extremely healthy, we always have a surplus on our balance sheet. So right now today despite the falls in markets, for every one Ringgit of member's accounts we have roughly RM1.05 or RM1.06 in assets. And that's taking into account the unrealised losses as well."
"So like I said we like to operate on a very conservative, very prudent approach and so you'll never see us recognising our unrealised gains in the P&L."
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