This article first appeared in The Edge Malaysia Weekly on May 15, 2023 - May 21, 2023

PRIME Minister and Finance Minister Datuk Seri Anwar Ibrahim, who rightly halted further premature Covid-19 withdrawals from the Employees Provident Fund during the pandemic, shocked those familiar with the EPF’s investments when opening Menara KWSP, the EPF’s new headquarters in Kwasa Damansara, Selangor, on May 8.

After declaring that he had “done his homework” when citing figures on the EPF to “impress” its CEO Datuk Seri Amir Hamzah Azizan, the well-known orator said he hoped the provident fund’s domestic investments would increase to at least 70% this year from 64% as at end-2022.

This six-percentage-point difference may not seem like much to most but because the EPF has a fund size of RM1 trillion, those six percentage points are equivalent to some RM60 billion. This is nearly three times the RM22 billion that, according to Amir in March 2022, the EPF had brought back, some prematurely, from its overseas investments to meet liquidity needs to satisfy Covid-19-related withdrawals to avoid rattling the local market.

The RM60 billion — about 3.5% of the country’s gross domestic product and Bursa Malaysia’s total market capitalisation — is also more than the largest dividend payout the EPF has ever declared to date — RM56.72 billion for 2021 — and some 17% bigger than the RM51.14 billion paid to members for 2022.

Portfolio managers for conservative funds would know how tough it must have been for EPF to build up its portfolio of foreign assets over the years. After all, competition is tough globally for high-quality strategic assets that can pay steady dividends or provide a decent fixed-income stream over the medium to long term.

As the EPF was created to safeguard and grow its members’ retirement savings, the provident fund cannot take on risky investments that may result in losses, though potential returns on riskier bets may look lucrative.

As the EPF’s fund size is still growing — with contributions expected to exceed withdrawals again this year after two straight years of rare net withdrawals in 2021 and 2022 due to Covid-19-related special withdrawals — a 30% cap of sorts on foreign investments means the EPF may be forced to accept lower returns as it has little choice but to invest more funds locally as the ceiling for foreign investments is lower than foreign assets in its portfolio.

If it is a directive, having more than 70% of its funds invested in Malaysia is in effect a 30% cap on its foreign investments.

We know for a fact that the return on investment for the EPF’s foreign assets is consistently higher than that for domestic assets, even though the latter is not always reported, given that the ROI for foreign investments is above that for the overall portfolio. In 2021, for instance, the ROI for foreign assets was 9.97% compared with only 4.76% for domestic assets, bringing overall ROI to 6.5%.

The EPF did not disclose its ROI for domestic assets for 2022, but said ROI for foreign assets of 9.27% was above its overall ROI at 6.2%. (See chart 1) 

Simply put, the EPF’s overall ROI would have been lower if there had been a smaller boost from the higher returns earned by foreign assets.

The Edge previously calculated that the EPF’s dividend for 2021 would have been nearer to 3.1% than 6.1% if the provident fund had invested its entire portfolio in Malaysia. (Scan QR code to read ‘The significance of foreign investments to EPF dividends’ published in Issue 1470 of The Edge Malaysia dated May 1, 2023)

The proportion of the EPF’s foreign assets had grown from 13% of its portfolio in 2011 to 30.3% in 2019.

During the Covid-19 pandemic, the proportion of foreign assets reached 35.14% of the EPF’s overall investment portfolio in 2020 and 37% in 2021, before easing to 36% in 2022. (See Chart 2)

What would have happened to the EPF’s dividends if the provident fund’s foreign investments had been kept at 30% in the past three years?

Had the EPF stuck to a hard 30% ceiling on foreign assets, dividends could have been some 20 to 50 basis points (bps) lower per year for 2020 to 2022, our back-of-the-envelope calculations show, going by the lower ROI for domestic assets.

Some might argue that there could have been a one-time boost in 2020 if the EPF had divested RM50 billion more foreign assets to bring the proportion of its foreign assets down from 35.15% to 30% of its investment portfolio. Wouldn’t that have shored up 2020 dividends by at least 50bps from 5.2% (conventional) to 5.7%?

If that one-time boost had been reaped in 2020, the EPF would not have that same foreign asset portfolio that helped deliver the 6.1% dividend (conventional) in 2021 and 5.35% (shariah) in 2022.

Put another way, after a one-time, say, 50bps, boost to dividends, the fund may have had to contend with 30bps to 50bps lower dividend a year thereafter due to the relatively lower ROI of some 4% to 5% brought in by domestic assets compared with 8% to 10% by foreign assets.

Should one be happy with RM50 more today if that comes at the cost of losing RM30 to RM50 every year thereafter?

Conversely, EPF dividends could have been some 20bps to 50bps higher a year earlier if the EPF had been able to raise foreign investments faster, our back-of-the-envelope calculations show.

If a one-time foreign asset selldown was done, there would have also been an even bigger one-time difference between the dividends paid to the conventional savings versus shariah savings. That is because foreign assets made up 43.6% of the EPF’s conventional portfolio versus only 24.1% of its shariah portfolio in 2022 — one of the reasons the EPF gave for why dividends for shariah savings were lower than those for conventional savings.  Foreign equities, which brought in 10.44% ROI in 2021, made up 24% of the conventional portfolio versus only 19.1% of the shariah portfolio in 2022. (See Chart 3)

If there is a hard 30% cap on foreign assets, more premature selling of EPF foreign assets may also become necessary if the ringgit were to weaken against foreign currencies as EPF assets are reported in ringgit terms. To account for foreign exchange movements, the EPF may even have little choice but to keep a lower proportion of foreign assets than it would have had there been greater flexibility as it has hitherto enjoyed — if there is a hard 30% ceiling on foreign assets.

Could the EPF place its hope on a stronger ringgit helping reduce the selling it needs to do to fulfil the 30% cap on foreign investments?

It is not immediately certain how much of the growth in the EPF’s foreign assets, from just over 30% of its total portfolio in 2019 to 36% of its total portfolio in 2022 (64% domestic), was because the ringgit had weakened against several currencies, particularly against the strong US dollar, in which more than 30% of the EPF’s foreign investment portfolio has been denominated in the past five years.

The EPF’s record RM68.89 billion gross investment income for 2021 received a RM1.36 billion boost from net gain on foreign exchange while also seeing RM6.16 billion net unrealised gains on improved mark-to-market value of its assets, according to its 2021 annual report.

EPF dividends are declared on realised gains, which is one reason why only RM56.72 billion in dividends were paid to members in 2021, its record high to date. The EPF has yet to release its 2022 annual report.

While expressing his “hope” of seeing the EPF raise domestic investments to 70% and asking that the provident fund widen the scope of its investments to take into consideration the current needs of the country and some of its people, Anwar in his speech also said that “the difference in his management” is that he “does not interfere in investment matters, as had happened in the history of the EPF”, without elaborating on the latter.

The non-interference, Anwar said, is “important because the [EPF’s] investment panel must remain an independent and professional panel that makes decisions based on the interest of contributors”, continuously seeking out new investments that would get better returns.

In his speech, what Anwar asks of the EPF investment panel is this: that it “expands the investment framework, for example, to include something [in aid of] start-ups, for young people in new economic sectors such as food security. These things should be given some consideration, in accordance with the government’s approach today to increasing [domestic] agricultural produce. It is not good for the country to be spending RM50 billion to RM60 billion on imported food items, so the approach of the investment panel should be modified to look at the big picture. It is not for the minister to order [the EPF] to invest in whichever company he chooses. This, I think, is important because it is in line with the governance and trust (Amanah) pillar of the Madani policy.”

This was mentioned in the same breath as Khazanah Nasional Bhd, the government’s sovereign investment arm, noting investments the EPF had made in strategic infrastructure like PLUS Bhd, which houses the North-South Expressway.

Yet an investment in a highway concessionaire like PLUS is not a strategic investment per se but one that is low risk and gives a steady stream of income that the EPF uses for dividend payments. If the new areas that the prime minister mentioned can be structured into low-risk investment instruments that give a steady income stream and good returns, it should measure well against investments with similar returns regardless of whether it is domestic or foreign.

Eyebrows may not have been raised had the “request” to expand investment scope been made without the prime minister and finance minister “hoping” that the EPF would raise domestic investments to 70% this year.

While both Khazanah and EPF are deemed government-linked investment companies, alongside the Retirement Fund Inc (KWAP), the Armed Forces Fund Board (LTAT), the Pilgrim’s Fund (LTH) and Permodalan Nasional Bhd (PNB), there is a distinct difference between these institutions — whether the funds managed belong to the government or otherwise.

For Khazanah and KWAP, the money belongs to the government. EPF money, like that of PNB, LTH and LTAT, belongs to its members.

It is perhaps this realisation that made Anwar express his wishes instead of making a hard directive. Given that he, too, wants the EPF investment panel to continue generating good returns for members, EPF members may not need to be overly concerned but should watch this space closely. 

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