In the first part of our series, we take a look at the Employees Provident Fund (EPF) which has some RM550 billion in its coffers. With such a huge fund size, the EPF has a sizeable impact on the local bourse. The question is, should the EPF as a pension fund with long term objectives be trading stocks, or stick to long-term investments? In an interview with KiniBiz, the pension fund’s chief executive officer Shahril Ridza Ridzuan sheds some light on its strategies.
On a daily basis, a chunk of the trading volume on the Bursa Malaysia comes from the Employees Provident Fund (EPF), either taking positions in companies or paring down stakes.
While details such as a percentage of the daily trades by EPF are hard to gauge, one merchant banker put it aptly when he said, “It would be very bad for (our) business if the EPF stopped trading.”
In an announcement recently, the EPF said that its investment income for the first quarter of 2013, had tumbled some 28% to RM5.6 billion down from RM7.7 billion registered for the corresponding quarter of 2012.
EPF’s explanatory statement meanwhile — that income in 1Q12 was boosted by one-off gains that were not replicated in 1Q13. A lack of volume on the local Bursa Malaysia in the first quarter also contributed to the decline in earnings this quarter — raised quite a few eyebrows.
EPF’s chief executive officer Shahril Ridza Ridzuan explained, “Last year we sold our interests in a couple of Singaporean shopping malls. We made a huge gain on that and it was booked in, but normally the trading part is mostly in our traded equities and in our traded fixed income. The trading profit that we make is very dependent on volume more than the market or price movement. Being a big (share) holder we can’t sell unless there is a buyer…so we need liquidity.”
In a nutshell, dividends are largely paid from realised returns from the trading of stocks on the Bursa Malaysia.
At present the EPF’s largest shareholding in terms of size is in Malaysia Building Society Bhd (MBSB), where the pension fund holds almost 70% equity interest, Malaysian Resources Corp Bhd (MRCB) where it has about 42% shareholding and RHB Capital where it controls a 41% stake.
All EPF’s stakes in other listed companies are less than 20%.
Interestingly enough market watchers have noted that the pension fund has been paring down its shareholding in two companies, which are traditionally favourites — Star Publications (M) and IJM Corp.
In Star Publications, which prints The Star, the largest selling English newspaper in the country, the EPF has about 6.2% or 45.49 million shares in contrast to 13.1% or 96.5 million shares held last year.
In IJM meanwhile the EPF now has about 11.9% or 165.37 million shares compared to a year ago, when the pension fund had 16.9% or 232.08 million shares.
Star Publications has shed about 13% of its value over the past year and hit a five-year low in early May this year, while IJM’s share price, over the past year, has gained by slightly less than 5%.
“(It could be) they (EPF’s fund managers) believe there’s better value elsewhere…We don’t have any real love, and we don’t have any emotional attachment to anything, else it clouds your better judgement,” he said.
EPF’s acceptance of the (low) MISC offer
A recent general offer by Petroliam Nasional (Petronas) for is 62.7% shipping unit MISC, put the pension fund in the spotlight as well.
While most minority shareholders and the analysts’ fraternity that cover MISC took the view that Petronas’ second offer of RM5.50 per share was too low, EPF accepted the offer.
It is noteworthy that at the time of the offer MISC’s net asset per share was RM4.84, which means the offer was a mere 66 sen or 13.6% above the net asset per share.
Shahril justified the acceptance, “You may think it’s undervalued, (but) we think that the price that was offered was fair… you see there’s unlikely to be dividend flow for the next one or two years, and like I said we are not a strategic investor. I have no vested interest in owning a stake in a shipping company,” he said.
Nevertheless Petronas’ privatisation effort was thwarted by the minorities.
EPF it seems had already taken the unrealised losses in its books, so the pension fund would have realised a decent gain at the RM5.50 offered by Petronas.
“Buying to hold works for some assets, but doesn’t for others,” he added.
How risky is EPF’s strategy?
Considering the market volatility, and the number of events which can cause the market to go into a tailspin, some of EPF investments could be dicey.
While EPF’s entire shareholdings were not readily available, some of its past investments (from a list in 2005), were interesting.
In 2005, the pension fund had about 17% in AKN Technology, 14% in Melewar Industrial Group, 12% in London Biscuits, 10% in ornamental fish breeder Xian Leng Holdings, 10% in shipping outfit Hubline, 9% in Konsortium Logistik, a 5% block in Kejurutraan Samudra Timur and 5% in Talam Corp (since renamed Trinity Corp).
It is not clear if EPF got burnt in any of these investments, but several of these companies are either de-listed, ailing, or have just recently turned the corner, after a bad spell.
“The question is what if the market crashes?” a market watcher asked.
“Overall their (EPF) strategy is all right…in good times they make, in bad times they make less. There is always a buffer in their dividend paying stocks. There is also a hedge with Government securities making up the bulk of their investments,” an analyst said.
The pension fund recently said that it had investments in 200 companies on the Bursa Malaysia out of which 40 are mid-cap counters. The EPF has also been reported to be looking to increase its investments in mid-cap stocks to 30% from the existing 20%.
Shahril disputes the risk involved.
“In terms of our accounting we are very conservative, which means we only recognise on our profit and loss account, dividends from realised returns, but we take in unrealised losses as well… because of this we are very careful.
“If you look at our balance sheet, you’ll notice that we have an aggregate of the unrealised gains of all our assets…the unrealised profit on all our assets. As of the 2012, it probably stood at about RM40 billion. Every year we take in unrealised losses through our profit and loss account, so our profit and loss account is basically about realised gains plus unrealised losses.
“If you don’t take the profit when it’s there, you don’t recognise a gain and the profit disappears when the market moves against you,” he explained.
He added that the EPF being a global investor, had many opportunities to invest, and was not limited in any way.
“The trading part of our business is very small. The bulk of what we hold in equities we tend to hold for the long-term but there is always a point where the market has moved where it is overvaluing that asset at that point in time, we will take profit as we know that the market will turn, markets never go up in a straight line and never go down in a straight line either,” Shahril said in conclusion.
Below are excerpts of the interview with Shahril on investment:
KiniBiz: The evidence is that EPF trades equities and bonds. Why is that? As a retirement fund should it not have a buy and hold strategy? Do you consider trading to be prudent?
Shahril: As a retirement savings fund, EPF is always committed to maintaining a prudent and low-risk investment policy. Therefore, EPF’s risk management strategy has always been to ensure that the appropriate amount of risk is assigned to each asset class.
EPF adopts a buy and hold strategy for the bulk of our investments where most of our funds are in fixed income instruments, in line with its prudent strategy to ensure members’ savings are well protected in the longer period. However, to enhance the value of the funds, EPF is continuously seeking for investment options which can generate potential higher returns while avoiding excessive levels of risk.
From time to time, depending on the market direction, there are opportunities for us to rebalance our portfolio for continuous returns and risk diversification. On top of that, EPF’s annual dividend is based on absolute or realised return. The EPF adopts a very conservative accounting treatment that is fully FRS 139 compliant. We only recognise gains that are realised – all unrealised gains remain on the balance sheet. However, we do provide for unrealised losses in our income statements – meaning that our balance sheet remains very healthy as unrealised losses are provided for annually through our income statement.
The trading income from active portfolio management allows our equities portfolio to generate additional returns rather than just from dividend yields. Even if the market and share prices goes up, it doesn’t mean that EPF’s income/dividend will go up in tandem unless we actively sell and manage our position on the markets. Vice versa, if the price goes down, it doesn’t mean that the income/dividend rate will go down unless we sell at a loss or take provisions in our accounts.
KiniBiz: What was the reason for the sharp drop in investment income for the first quarter of this year?
Shahril: During the first quarter of this year, the capital gain generated the from domestic equity portfolio was not as huge as compared to 1Q12, mainly due to a significant lack of market volume to facilitate the trading activities. 1Q12’s performance was also boosted by gains coming from one-off investment transactions. This kind of tactical one-off transactions could not be replicated every quarter or every year. It could only happen when opportunities arise and markets permit.
KiniBiz: How do you make decisions on which brokers to use and how do you assess their performance?
Shahril: EPF has its own list of panel brokers which were selected from stockbroking companies licensed by the Securities Commission and approved by the Management Investment Committee (MIC) via a strict selection criteria. Their performance in terms of service levels and research capabilities are examined every six months.
Our criteria covers strength of shareholders, management profile, size & quality of market reach, IT system & physical infrastructure, strength of team, specific issues on equity research and other value add. Financial criteria includes their leverage ratio, Tier-1 capital ratio, risk-weighted capital ratio and profitability.
EPF allows the external fund managers to actively manage (within our mandate terms) the funds allocated for them. They were appointed for their skills, expertise, experience and knowledge on asset management for the respective mandates. Accordingly, we do not interfere with or get involved with their investment process – their performance is evaluated quarterly to test how they are performing against the benchmarks set for them and against their peer group.
KiniBiz: It is difficult to track EPF’s specific investments and performance. Why doesn’t EPF, like other retirement funds around the world, disclose specific investments, cost of acquisition and cost of disposal for investments bought and sold? Don’t you think the transparency will promote better governance and accountability?
Shahril: We comply with all disclosure requirements of every market that we trade in and ensure full compliance with all regulatory requirements of their respective regulators / authorities. We believe that as a very large and active market participant, the interests of our members are best served by not providing any information to the market that could be used to trade against our positions.
KiniBiz: Why does EPF not have specific investment policies and targets for different classes of assets and sub-classes within this? That way it will be easier to assess investment performance. What is your investment policy in terms of asset classes as well as target returns overall and by asset class?
Shahril: EPF’s primary long-term investment objective is to preserve the capital of our members’ savings, i.e. to take minimal risks in order that the principal value of our members’ savings will not deteriorate. Hypothetically, each asset class behaves differently in different market conditions. Therefore, the performance of each asset class differs from each other at any particular point of time. EPF is a balanced fund where optimal asset allocation is crucial and the key factor of success in achieving its long term investment objective is through diversification.
A good indicator of adopting an optimal asset allocation is when over a long-term horizon, the total asset returns has demonstrated sustainable performance. In this sense, the EPF’s diversified asset allocation is designed to target a rolling real (less inflation) dividend of 2% while still minimising the chances of a loss of principal capital.
KiniBiz: What was the reason for EPF accepting Petronas’ offer to buy MISC shares ahead of the close of the offer and accepting it at a price that many thought was undervalued?
Shahril: The question of valuation is very subjective. Considering the shipping industry has been very weak in recent years (with volatile charter rates) prior to the offer, EPF felt the price was quite fair. Although the LNG business is stable and generates good cash flow to MISC, we have factored in the value of the LNG business in the pricing.
The EPF is a global investor with access to many markets and companies – we are not a strategic investor and accordingly, we felt that the offer provided a good opportunity for us to cash out of an illiquid investment that was unlikely to provide good and consistent dividends. If the offer had been successful, the EPF would have booked a significant gain on the transaction and been able to reinvest the proceeds in other companies with better prospects of dividend flows.
KiniBiz: Is there any government influence over investment decisions? What plans do you have to make the investment process more transparent and accountable?
Shahril: All investment decisions and activities are analysed and undergo detailed screening by the Management Investment Committee, Management Risk Committee, Investment Panel Risk Committee and the Investment Panel before we move forward. We only pass resolutions after evaluating how these deals will positively benefit our members.
EPF strictly adheres to its Strategic Asset Allocation which is designed to maintain consistent returns in the long run within tolerable risks limits for each asset class. The decisions made are purely commercial investment decisions without any external intervention.
Tomorrow: Does EPF provide enough at retirement?