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Author: savemalaysia   |   Latest post: Fri, 22 Nov 2019, 6:03 PM


A new challenge for the EPF

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The provident fund would be challenged to declare steady dividends if it is restricted from putting more money overseas

BY any account, a dividend rate of 6.15% by the Employees Provident Fund (EPF) in a year when the local stock market declined by 6% is a great job done.

Not many mutual funds or even pension funds would have been able to manage that kind of returns in an environment where volatility was the norm for both the domestic and overseas markets. The third quarter of last year was especially a disaster for the equities market.

One of the reasons said to have enabled the EPF to declare a dividend of 6.15% despite Bursa Malaysia falling by 6% is the change in accounting rules, which gives leeway to the provident fund to not impair in full the value of its listed entities.

Previously, the accounting standards required funds such as the EPF to provide for impairments in its non-core equity holdings. The impairments would have had a negative impact on the EPF’s income statement and consequently, the dividend rate.

The EPF’s dividends are declared based on its realised returns and after taking into account the diminution in the value of its assets.

For instance, in 2017, the EPF declared its highest dividend rate, which is 6.9%, and a large part was due to the performance of Bursa Malaysia which ended that year with a rise of 9%. In 2015 and 2016, the EPF’s dividend rates trended lower in tandem with Bursa Malaysia, which declined 4% and 3%, respectively.

Some analysts estimate that the EPF’s dividend rate would have been about 5.8% or lower for 2018 if the previous accounting rules had been applied.

Nevertheless, the accounting rules have their positives and negatives.

The bad part of the MFRS9 is that it allows funds to prolong the painful process of providing for any diminution in the value of their assets. So, over the longer term, the real value of the fund may not be reflected in its books. It could be holding stocks in its portfolio whose value have declined significantly.

However, the good part of the rule is that it allows for bigger funds that get more money than withdrawals, such as the EPF, to hold on to stocks and not worry about providing for the deterioration in value on a yearly basis.

Funds such as the EPF do not have to worry about meeting redemption obligations.

However, the smaller funds cannot afford to hold on to stocks for the longer term without impairing because they would need money to meet redemptions.

The new accounting rules call for fund managers to be even more diligent in their selection of assets if they want to consistently give returns that are near or better than the performance of the broad capital markets.

In this respect, the EPF already has a robust selection process of where the money can be invested, especially for stocks. It has a management committee that screens the investments before proposals go up to the investment panel, which comprises personalities from outside the provident fund.

Some 15 years ago, the EPF had more than 400 stocks and many were not performing. The fund did a major clean-up, reducing its holdings to about 120 stocks. Dividends were affected during the clean-up process.

Since then, the EPF has been declaring dividends from its investment gains realised after providing for any diminution in value of its assets. It is a prudent practice and allows for a more stable dividend rate that is less affected by the movements in the stock market.

For instance, the stock market had negative returns in the years 2014, 2015 and 2016. The EPF’s dividend rate was 6.75% in 2014 helped largely by the superb performance of its overseas investments.

But the dividend rates came down to 6.4% and 5.7% in the subsequent two years. If the impairments were not provided on an annual basis, the returns from EPF could have been volatile.

A way forward to better manage the situation for a fund the size of the EPF is to allow it to place more money outside the country to diversify its risk.

The EPF’s fund size was RM833.8bil as at end-2018, which was almost 65% of the RM1.3 trillion Malaysian economy.

More than 70% of the EPF’s funds are invested within Malaysia, which is bad because it causes an artificial inflation of asset prices.

A clear example is the stock market where the EPF is a major shareholder in all the major companies and does not sell its stake because there are limited places to put its money in.

If the EPF sells, it will be a disaster for the stock, as we saw in the case of FGV Holdings Bhd. At the rate the fund size is growing, it would be a matter of a few more years before the size of the EPF is equivalent to the Malaysian economy.

If 70% of the money is retained within the system, then the value creation of new wealth will be minimal.

The authorities have to give the EPF more leeway in placing some of its funds outside Malaysia. It diversifies the risk and will give the fund more options in handling domestic investments which have not yielded the desired results.

At the moment, there are restrictions on the EPF to take more money out of the country because it supposedly affects the ringgit. However, with the new government’s promise to better handle public funds, the ringgit has its own strength to depend on.

If the EPF wants to put more money outside Malaysia, the fund should not be impeded by ringgit concerns.

Read more at https://www.thestar.com.my/business/business-news/2019/02/23/a-new-challenge-for-the-epf/ 


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