In September 2016, Shahril Ridza Ridzuan, Chief Executive Officer, Employees Provident Fund (EPF) in Malaysia, spoke to Victoria Barbary, Director of Strategy and Communications at the International Forum of Sovereign Wealth Funds about the challenges facing his organisation as a long-term investor. They also discussed the particular challenges facing institutional investors in South-East Asia, as the Chinese economy, which has been the powerhouse of growth in the region, rebalances and slows. Finally, they discussed the new role of environmental, social and governance issues for the EPF.
- Shahril Ridza Ridzuan, Chief Executive Officer, Employees Provident Fund in Malaysia
- Victoria Barbary, Director of Strategy and Communications at the International Forum of Sovereign Wealth Funds
Shahril Ridza Ridzuan: The EPF is a retirement savings fund for Malaysia’s private sector workers. It is a defined contribution fund and we represent approximately 14.55 million members, which is about half the Malaysian population. We are roughly US$185 billion in terms of asset size, and one of the 10 largest state-run retirement or pension funds in the world. About 27% of our assets are allocated outside of Malaysia.
Both employees and employers contribute monthly to the fund and this is mandated by law. Employees, who are EPF members, must contribute a minimum of 11%, while the employers’ contribution is 12% to 13% depending on income levels. We enforce the contributions and pursue defaulting employers. Our nationwide network of 68 branches offers members’ services ranging from handling complaints to withdrawals.
The EPF is based on the concept that people save as they go, and then they withdraw the money when they reach retirement. We have multiple options for members on how they can withdraw their money, whether lump sum, partial, monthly, yearly, etc.
Victoria Barbary: As a defined contribution fund, how has your investment strategy evolved since the global financial crisis?
Shahril Ridza Ridzuan: We have set key financial metrics and targets, with the intention to minimise risk to members’ capital and limit drawdowns. Our main objective is to achieve inflation plus 2% over a three-year rolling period. We are educating our members that it is better to have a long-term sustainable real return fund, as opposed to maximising the nominal yield. This is particularly challenging in the today’s current global economic environment. Although yields today are pretty low by recent historical standards, we are still able to meet our targets.
Victoria Barbary: How has your asset allocation evolved given the trend towards private equity, infrastructure and real estate? How has integrating that illiquidity changed and evolved the way that you manage that portfolio?
Sharil Ridza Ridzuan: Until the early 90s, the Fund consisted of 90% Malaysian fixed income and government securities - it was a safe and conservative portfolio. But over time, that changed as we started to focus on providing a real return on members’ capital. We began to invest in equities in the 90s; and thereafter, started to invest in Malaysian illiquid assets such as private equity, property and infrastructure. In the early 2000s we had to start investing overseas to reduce the pressure of trying to find enough Malaysian investments. We had become so big that we started to crowd out other Malaysian investors.
When I joined EPF in 2009, about 5-6% of the Fund was invested in global assets. Now we are about 27% in global equities and fixed income, the bulk of this being in the more traditional asset classes of equities and fixed income. Our total investments in illiquid assets is approximately 5% of our actual deployed capital. If we include private equity fund commitments, this figure is probably closer to 7-8%. We think it should be roughly about 10% considering where we are today, and we expect to grow to about 15% over the next 5-10 years.
Victoria Barbary: What are the challenges of growing that illiquid allocation? Have you had to build teams in-house?
Sharil Ridza Ridzuan: The challenge for us to grow illiquid assets is that a lot more due diligence is required for every single investment.
Yes, we do a lot of it in-house. We first started out in private equity, we started with a fund-of-funds programme. We use a few key global partners and part of the mandate of those partners was helping us develop the structures, methodologies and talent needed to bring asset allocation in-house. Much of the work was in training our people with the right skill sets and experience. Today, we manage about 90% of our assets in-house, with just under 350 investment professionals and we are very comfortable with this.
Victoria Barbary: What do you use external managers for today?
Sharil Ridza Ridzuan: We use external managers in new areas we want to move into or where it’s too difficult to build up the resources ourselves. For instance, when we first started investing in global equities, we gave out mandates as we didn’t have enough internal expertise. But we gradually built teams to mirror their processes, and eventually most of the money, about 70%, is now managed in-house. We currently use external fund managers for private equity, but we are starting to develop the ability to run that in-house as well.
Victoria Barbary: Where are you seeing the best opportunities? Where might you want to increase and enhance your skill-set as a team?
Sharil Ridza Ridzuan: For us, diversification is key to the stability of our fund so it’s about making sure we have the right balance among all out asset classes. We feel that we’re still a bit short in the illiquid inflation asset classes so we’re putting more emphasis on that. Our London office, for instance, deals only in illiquid assets. So essentially, all trading for fixed income and public equities are all done out of KL (Kuala Lumpur), but we actually do split the sourcing and deal-making for the illiquid asset class between our KL office and the London office. In London, especially with due diligence for documentation and deal-sourcing, we are gradually ramping up of our capabilities along that space. That’s an area where we need a very different kind of expertise. You need a whole host of skill sets, not just fund management.
Victoria Barbary: As a South-East Asian investor with a lot of domestic investment, how is the slowing of China affecting your domestic investments vis-a-vis your international investments?
Sharil Ridza Riduzan: The ASEAN region is about half a billion people; that is a very big marketplace with huge trade and GDP growth even among member countries. So how we view the geographical split is we have the ASEAN region and North Asia, which includes China, Korea, Taiwan and Hong Kong. Japan falls within our developed markets’ mandate.
We tend to view ASEAN and North Asia as equal weights. Obviously due to our position within Malaysia and our close business links in the region, we have a lot more comfort and visibility in ASEAN. We have informational advantages here, whereas in North Asia we’re just another investor.
We’re obviously keeping an eye on China – its growth is a major factor in ASEAN trade into North Asia as well as global growth, but we have always believed that over the long term, these things tend to even out. While we view today’s period of low growth with concern, the big benefit of China from an inflation hedging perspective is that it has been exporting deflation for a while now. So we’re still comfortable with our inflation spread targeting and having the right diversification of assets to meet that.
Victoria Barbary: How have your views towards risk changed over the years?
Sharil Ridza Ridzuan: That is an interesting question at this time. As you know, many investors have been accustomed to decent nominal yields so it’s difficult to wean yourself off that. Five years ago, members were targeting inflation plus 2% and therefore returning 6%. Today returns are at 4%, but still on an inflation plus 2% basis. Technically on a spread or inflation hedging basis, you’re fine, but there are psychological hurdles. The problem is exacerbated for pension funds who have to meet defined obligations, predicated on a particular rate of return. If your model has always been based on achieving 7-8%, today that means doubling the risk taken.
It’s hard for us to educate our contributors that 6% plus returns are a thing of the past unless you want to take on a huge amount of portfolio risk, as pensioners don’t think in terms of spread. Our challenge is to educate our contributors (our 14.5 million members) that inflation plus 2% is a good target to have, especially if this means plus 4% returns. Plus 6% nominal returns is a thing of the past and you would have to take on a huge amount of risk.
Victoria Barbary: Have you had a lot of pressure or requests from members to focus on the environment and social governance issues?
Sharil Ridza Ridzuan: When you represent 14.5 million people, there’s going to be a section of the membership that just want to maximise returns. But today an increasing majority of our members are concerned about sustainability issues and what we are investing in are in line with their values. People do not want to be associated with industries or products that they view as harmful or not aligned with their beliefs.
Several years ago we embarked on a more ESG-focused stream of investing. We have publicly stated that the EPF would not invest in gambling, alcohol or weapons production. We still have some old investments in tobacco, but these eventually will be sold down and no new money invested in tobacco.
Victoria Barbary: Is Sharia-compliant investing something you are looking to expand?
Sharil Ridza Ridzuan: Sharia investing goes hand-in-hand with ESG and sustainability. The industries that you have to avoid in order to be Sharia-compliant, you would have to avoid anyway for ESG compliance. The key difference is that conventional, interest-based banking is excluded from Sharia investing. It’s our view that Sharia investing is a subset of ESG. In that sense, it’s actually ESG plus another filter based on banking.
Due to our push towards ESG compliance, there hasn’t been much issue of being Sharia-compliant at the same time. Our portfolio today is roughly 90% ESG-compliant and about 45% Sharia-compliant. We are probably the single largest Sharia-compliant investor in the world.
Members who wanted a fully Sharia-compliant asset pool now have the option of converting from the current ESG conventional pool to a fully Sharia-compliant pool. We successfully launched Simpanan Shariah, the fully Sharia-compliant fund on 8 August 2016, with an allocation of MYR100 billion. We saw a 40% uptake in the first month; our members are excited about it.
Victoria Barbary: Do you expect to continue to expand that allocation?
Sharil Ridza Ridzuan: I think so. We’re encouraging people to view Sharia investing as a subset of sustainable investing. Within Sharia, financing is meant to be a risk-sharing concept whereby, the providers of credit and the providers of equity are supposed to share risk. So it’s a form of sustainable banking.
Victoria Barbary: What do you see as the major trends for long-term returns?
Sharil Ridza Ridzuan: It depends on fund type, time horizons and your investment objective. For our Fund, a more balanced diversified asset class is still good. Because we have an inflation spread mandate, we would like to acquire more inflation-hedged assets, like infrastructure, property assets or even inflation-linked securities.
Victoria Barbary: Are there any areas where you think you’re not getting properly compensated for the risk you’re taking?
Sharil Ridza Ridzuan: As an institution, we think that the risks involved in higher-grade credit are not as well-priced in as we would like. We also struggle with technology company valuations, especially internet or new economy companies which don't make any money, but have ridiculously high valuations. We prefer cash flow driven companies. We have always been motivated more by cash flow and dividend yields, but less so on absolute capital gains. It makes our life easier in terms of predicting and managing our members’ returns. This keeps volatility low and our members happier, which to be honest – makes life a lot easier.Ritorna a Investment Institute