Prime Minister Datuk Seri Anwar Ibrahim has called on the Employees Provident Fund (EPF) to reduce its overseas investments to no more than 30% of its total investment assets by the end of this year, in favour of supporting the domestic capital markets, strategic industries and infrastructure investments. We wrote about the same idea in this column back in 2021 (you can scan the QR code for the full article, “Addressing structural weakness for Bursa’s underperformance”, published on Jan 18, 2021) — and decided to revisit the subject this week, in light of recent developments.
There are obvious benefits as well as drawbacks, with long-term consequences for the rakyat — and, as such, we think it is important to understand and carefully take all the implications into consideration.
As a matter of public policy, repatriating domestic savings and reinvesting the money locally make perfect sense. The benefits to the economy and country are many, obvious and rational. This will provide a boost to both the stock and bond markets, investments, central bank reserves and the ringgit, and help ease cost of living pressures.
On the other hand, the EPF is the custodian of compulsory savings and retirement fund for all employees in the private sector. Its sole mandate is to safeguard and grow the retirement fund for members (8.4 million active contributors), which is critical to securing their financial futures. This should not be taken lightly. Already, too many Malaysians have insufficient savings and risk facing poverty in old age.
Does the EPF, as an independent private institution, also have a duty to support public policy and promote economic growth — and the welfare of all non-members — in the country? And critically, how should it balance the inevitable trade-off when both objectives are in conflict? It leads to another question: Are trade-offs “inevitable”?
For the good of the country …
The EPF controls the single-largest pool of domestic savings in the country, with investment assets totalling more than RM1 trillion as at end-2022. Of this, about 64% are currently invested domestically with the balance 36% allocated to overseas assets. If it were to shift its portfolio of investments today, and raise domestic investments to 70% of total assets, this would mean an infusion of roughly RM60 billion in “fresh funds” into the domestic economy.
First off, the repatriation of RM60 billion in foreign currencies would boost Bank Negara Malaysia’s foreign currency reserves and demand for the ringgit, and strengthen the currency’s value. This would help reduce imported inflation and provide some relief to the rising cost of living. For perspective, our reserves now stand at about RM505 billion.
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If the monies are then allocated based on the retirement fund’s current portfolio composition, the stock and bond markets will see some RM25 billion and RM28 billion in fund inflows, respectively.
Inflows into the bond market could be used to fund public and private projects as well as government fiscal deficits, thereby keeping interest rates lower than they would be otherwise. Lower interest rates, in turn, will reduce the debt servicing costs for businesses, households and the government. In short, it will be positive for the economy.
Similarly, the additional fund inflows can be expected to boost stock prices on Bursa Malaysia. Although RM25 billion is only about 1.5% of the total Bursa market cap (of roughly RM1.7 trillion), remember that stock prices are driven by marginal demand and supply. Case in point: Annual foreign fund flows have been much lower than RM25 billion — yet, foreign buying/selling has a strong positive correlation with the stock market’s performance, historically. The point is, it does not take a lot to move prices, and create a multifold wealth effect for all shareholders in the stock market.
Going forward, increased investments by the EPF in Bursa — from future contributions, if its overseas asset allocation is to be capped at 30% — will, at least, partially offset foreign selling. Persistent foreign selling — in seven of the past 10 years as well as for the current year to date — is one reason for the chronic underperformance of Bursa. The bellwether market index, FBM KLCI, has fallen by 16% over this period.
Having said that, there is also a negative side effect as large institutions such as the EPF and Permodalan Nasional Bhd become increasingly dominant in the market. They stand ready to buy or sell, thereby reducing market volatility. It may be counter-intuitive but some degree of price volatility is required to make a robust market with vibrant trading activities.
As we said some weeks back, unless reversed, this will only self-perpetuate — no one invests in markets that do not perform and owners do not list their companies in “undervalued” markets. The latter is especially true for large, quality and high-growth companies that are being constantly courted by competing stock exchanges.
Consider this: The 30 FBM KLCI component stocks account for 59% of total market capitalisation for Bursa. By comparison, the 30 stocks that make up the Dow Jones Industrial Average account for a little over 23% of total market cap for all companies listed on the New York Stock Exchange. Clearly, Bursa lacks depth and width. Too many of the companies listed on the bourse are too small and insignificant — 69% of all Bursa-listed companies currently have less than US$100 million (RM450 million) in market cap. This does not bode well for the development of the local capital market and, by extension, the economy — when companies cannot raise funds at valuations they deserve to undertake research, innovate, improve productivity and expand capacity. The lack of quality options also means that Malaysians will look elsewhere to put their savings to work. In other words, domestic savings and capital outflow. It is a vicious cycle.
For more stories about where money flows, click here for Capital Section
To summarise, there is intense competition for foreign funds, be it foreign direct investments or portfolio monies. And, as we have shown previously, Malaysia is losing out on both fronts to its Asean neighbours. The implication is clear — we need to focus on the better application of domestic savings to drive future economic growth.
And since the EPF is the institution that acts as custodian of private domestic savings, it would be irrational, illogical and irresponsible if it does not also bear the burden of a national agenda.
Unfortunately, as we have explained many times, there is no such thing as a free lunch in economics. Someone takes and someone else has to pay. In this case, asking the EPF to forego higher returns on its overseas investments and reinvest in lower-return domestic assets means reduced overall returns for all of its members.
… at the expense of all EPF savers
Since 2010, the EPF has more than tripled its percentage of total investment assets overseas for this simple fact: to earn higher returns for its members, as per its mandate (see Chart 1). And this has proven to be the right decision.
We estimated the return on investment (ROI) for both its overseas and domestic investments since 2010. Note that some of the figures are approximations, in the absence of actual statistics from the EPF. Nonetheless, the trend is very clear and verifiable based on the actual relative performance of the FBM KLCI against global bellwether indices. For example, the S&P 500 is up 190% while the FBM KLCI is down 16% over the past decade (yes, you read that right … no printing error here).
The ROI for its overseas assets has consistently outpaced that for its domestic assets, boosting overall returns (see Chart 2). For instance, the ROI for foreign assets was 9.97% in 2021 — more than double the 4.76% for its domestic assets. Last year, overseas investments generated 55% of total gross investment income even though they accounted for only 36% of total investment assets. The higher ROI, in turn, translates into higher annual dividends for members. Even a small increase in the annual dividend payout can make a substantial difference over the long term, due to the compounding effect.
We did a simplified back-of-the-envelope simulation, assuming the EPF did not raise the percentage of its investments abroad since 2010. That means the ROI for subsequent years would be lower, and equal to its domestic ROI. And so would the dividends paid — dividends cannot be sustainably larger than income (see Chart 3).
If you were to project the math over a longer period, you would find that your retirement nest egg would end up being far smaller. It will make a material difference to a large number of Malaysians who depend on their EPF savings in old age, especially taking into account cost of living inflation.
Conclusion
There is no question that reinvesting domestic savings in the country is positive for driving future economic growth. But the EPF’s current sole mandate of safeguarding and growing the retirement fund for members must also be secured, protected and respected. There is no such thing as a free lunch in economics. Therefore, the inevitable trade-off needs to be carefully weighed as the consequences can be huge. And if the EPF does decide to trim its overseas assets, it should be done in a way that will ensure the best possible outcome for members.
For instance, its bond investments are not mark to market — accounting standards do not require mark-to-market valuations if the bonds are intended to be held to maturity. Prematurely selling its foreign bonds would mean realising paper losses — since global bond values have fallen sharply over the past year, on the back of steep interest rate hikes — that translates into real losses for members.
Additionally, if the EPF is to raise its holdings of equities in Bursa over the next seven months — by some RM25 billion — it is simply asking for speculators to take advantage of the fund. We could envision market players making easy profits buying the stocks today and selling them to the EPF over the coming months.
While we believe it is critical for the nation to gain more investments — and yes, the EPF is an important source — we would caution against “knee-jerk” solutions or “steroid-like” prescriptions. Furthermore, even though increasing the EPF’s domestic assets allocation will result in a larger pool of funds going forward, the immediate stimulus from the repatriation of RM60 billion is a one-off event. In other words, the big boost to the bond and stock markets is, largely, short term — and will wear off once the additional inflow of cash is spent.
Actions have consequences and outcomes. And how one relates to another is not just the decision itself but also the execution and the accompanying actions and strategies. Notice that we mentioned the “inevitable” trade-off for the EPF several times in this article. This is an accurate description based on historical performance. But it does not have to be the case. Investing more domestically and falling total returns to the EPF is not an inevitable trade-off. Yes, the answer lies in raising domestic returns.
As we wrote above, the key to reinvigorating interests in — and the performance of — Bursa in a sustainable manner is to improve its depth and width of listings, earnings and valuations. Some weeks back, we wrote about the role shareholder activism and share buyback can play in monetising value. It requires taking the necessary steps to make investing in Malaysia attractive again to all investors (domestic and foreign) as well as addressing the root causes for poor corporate profitability and slow productivity growth. Otherwise, the lack of quality options — and secular decline in the ringgit — will only see ordinary Malaysians continuing to invest their hard-earned savings in other more attractive markets.
In short, the retaining and better application of domestic savings has to be coupled with underlying structural reforms for the positive effects to be sustainable. There is no easy fix, certainly not one that can be resolved in the next seven months. The nation needs a comprehensive and holistic national development strategy, and we have referenced this in many of our past articles.
The Global Portfolio fell 1.1% for the week ended May 17, weighed down by losses from Star Media Group (-9.5%), BYD Co (-1.5%), and Insas (-0.9%). Alibaba Group Holding (+6.6%), Tencent Holdings (+4%) and Meituan (+3.1%) were the notable gainers last week. Total portfolio returns since inception now stand at 26.2%, trailing the MSCI World Net Return Index’s 47.1% returns over the same period.
The Malaysian Portfolio also ended lower last week, falling by 2.8%. Shares for Star Media Group (-8.1%) and KUB Malaysia (-1.0%) traded lower while Insas (+0.6%) and ABF SG Bond Index Fund ETF (+0.2%) gained. Last week’s losses pared total portfolio returns to 159.8% since inception. Nevertheless, this portfolio is outperforming the benchmark FBM KLCI, which is down 22.2%, by a long, long way.
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