Tuesday, January 10, 2006

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".

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