Revamping Our Pension Scheme

• News reports indicated that the government will roll out a private pension scheme initiative by the middle of next year, as part of its reforms to the existing pension funds industry.
• Securities Commission task force will submit a report on the private pension scheme to the government in the next six months.
• "There will be three legs under the pension reforms - the government pension scheme, the EPF and the private pension funds," he said. Nor Mohamed said the EPF scheme will be reviewed since the government does not want one fund to constitute the major portion of the Malaysian capital market.

My views:

- Will this mean EPF does not have the capacity to invest more funds? Or is EPF running out of local cagamas / bonds to park the funds to?
- EPF might be taking the proper route here in that it can only manage a certain projected return of 4%-6% if 70% of their funds are in top rated ringgit papers, the rest primarily in local stocks and the rest in overseas stocks. If they put too much in foreign currency bonds or foreign stocks, EPF will have a lot less control of the investments. The foreign currency aspect will swing returns to unacceptable territory. How would you like your EPF annual returns to be swinging between the range of -3% to +8%?
- The major development is to help cover those 2 million currently outside the ambit of EPF, that is a noble thing to do.
- The secondary objective is to provide "approved funds" to take the burden off EPF. If it was up to me, I would suggest that one should have the option of putting 50% - 100% of contribution for EPF to manage. If you wish, you can allocate up to 50% of your EPF funds into approved funds.
- Let's remember the wonderful example of the USA's 401k, you get to choose to put your 401k into funds. Many people lost 30%-60% of their 401k. Now please imagine losing 30% to 60% of your retirement EPF funds in just one year.
- Sure you could also get those who can get superior returns in the 401k, but is that what a superannuation fund is for? You do not need the 20%-30% return a year for something like your superannuantion fund. First objective of a super fund: DON'T LOSE ANY MONEY. Second objective: Make something decent that is a bit above prevailing interest rate.
- Anything more than that will result in greater returns, yes, but as well as greater risk. Talk to those who lost 30% to 60% in their 401k, I am sure they would have loved to have been in EPF from day one.
- Some who speculate that compulsory contributions to EPF will be cut is looking at the wrong angle. Overall contributions won't be cut, but the public will have the choice to allocate to other approved funds.
- This WILL NOT mean EPF will then cut their stakes in local companies, that is flawed thinking. EPF will not need to cut its stakes at all.
- The SC will have to be very careful in selecting the approved funds. I hope not to see favouritism. Approved local funds should have size (proven size, managed decent sums before, RM300m for equity, RM1bn for bonds), proved records for at least 3 years, preferably 5 years. I would want to see some foreign funds being approved as well, the criteria could be more stringent, minimum US$500m for 5 years of beating respective benchmarks, US$3bn for bond funds and minimum 5 year track records. Some attention should be paid to foreign currency exposure - while most international funds are valued at USD, a fund that is somewhat "hedged to the ringgit" will help. For example if Aberdeen Asset wants to be an approved fund, it will need to mark their returns for that fund back to ringgit even when running a foreign equity or bonf fund.
- When selecting an approved fund, do not get bogged down using too many parameters. The alphas, betas and gammas can be very distracting. The risk measure is ok as its a good indicator to see how much risk is required to get their required returns. Turnover is a so-so measure, let the fund manager manage his/her way. Is it a personality driven fund or otherwise, state out how you would regard each category, what to do when the star fund manager leaves. I would watch closely the cost of entry and exit as this is public money. I would strongly advise to have lots of indexed funds, which will have very low management fees (many are below 0.75% p.a.). Many funds have to charge 3% to buy into their funds because they rely too much on agents, discard them. If you want to be an approved fund, entry/mgmt fee together should not be more than 1.5% p.a., the public should not have to bother with the fact that you do not have size. Its not a personal investment issue, its a national retirement fund.
- While we are at it, revamping EPF, please come up with a viable ANNUITY plan. Its a simple plan, it has been mooted before, why are the insurance companies so greedy - kick out those greedy ones. This is very pressing because we know that more than half of all retirees finish ALL their EPF monies within 3 years. That defeats the purpose of retirement income.
- An ANNUITY plan would allow pensioners to buy units of Annuity for life. For example, if it cost RM60,000 for one unit that would pay RM500 per month for life ... (an expert could come up with a more realistic calculation, I am not an actuary). Then one could buy 3 units for RM180,000 upon retirement and will be guaranteed RM1,500 tax free per month for life, and so on.
- It does not have to be compulsory, but there has to be a credible choice upon retirement.




p/s photos: Cherry Ann Kubota

EPF's Returns vs Armed Forces Fund's Returns

I was browsing through The Star paper and came across this letter to the editor from a Dr. Chang from Klang. He cited the impressive performance of the Armed Forces Fund, which recently announced a 15.75% payout to its contributors for the last financial year. The returns included a 7% dividend, a 3.75% bonus and a special bonus of 5% in the form of free unit trust units. Dr. Chang further compared that with the sedantary EPF which declared a dividend of 4.75% for 2004. Naturally, Dr. Chang implored EPF to shore up its performance to at least somewhere closer to the Armed Forces Fund.

EPF is a convenient punching bag for all. I think 4.75% last year from EPF is decent, not in the "very good" category, but decent. There are a few things that Malaysians who contribute to EPF must know:

1) EPF is very big, and the amount of fresh funds coming in every month is also substantial. To move those funds into appropriate assets is not easy.

2) It is a pension fund, not an equity fund or even a convertible bond fund, certainly not a futures and options fund. As such, Malaysians SHOULD HOPE that EPF do not produce returns of 10% a year, because that means that they have taken on a lot more risk than the fund should to obtain that kind of return. You cannot get supernormal returns relative to prevailing interest rates without taking on a lot more corresponding risk.

3) Yes, the Armed Forces Fund produced superior returns, but I do not know the makeup of their assets exposure. I certainly hope this is a one-off for Armed Forces Fund because if they continue in that vein, it spells trouble. A one-off superior return can be acceptable, e.g. they could have sold a building at a very good price, and the book value of the building has not been revalued for a long time. You get the drift. If the Fund was speculating in some leveraged trading or hedge fund or speculative second or third liner stocks to get that superior return, somebody should at least audit the Fund's transactions and exposure. In fact, somebody higher up should do so already!!!

4) Other "good explanations" for the Fund's good performance could be allocations on certain IPOs that did very well - but those kind of things would not make a dent on the EPF's overall performance. EPF need to keep the bulk of it in local currency, and then mostly in bonds, the closer to risk-free the better. It may diversify some to foreign equity but not much, or foreign bonds particularly of our trading partners - it all has to do with balancing risk of the pension fund. Hence Malaysians certainly should not expect EPF to produce returns more than two hundred and fifty basis points than the prevailing interest rates (e.g. interest rates is 3.5%, EPF should not put up a dividend more than 6% - if they do, alarm bells should be ringing, maybe they increased their exposure to equities excessively).

5) One thing the EPF should stay away from is to act as a piggy bank for certain dubious equity holdings or loans. So far, we did not see an implosion triggered from these transactions, well, probably because as a percentage the amount is still small. However, we must strive to uphold the integrity of the pension fund and never to use it as a dumping ground or lender of last resort.

So, Dr. Chang, be wary of excessive returns, its like a girl who agrees to go home with you after 5 minutes talking at the bar - something that good gotta be "not right".