Tuesday, March 17, 2009

EPF vs LTAT Again

As usual, every time EPF declares its annual dividend, there will be scores of groups who will be up in arms at how the returns could have been so much higher. A disclaimer: I have not been paid a retainer or fee by EPF for writing this posting. Many people have been wondering how and why LTAT can post such enviable earnings and dividends to its members for the past few years. Why can't EPF even come close to it? The Lembaga Tabung Angkatan Tentera (LTAT) group posted a 45.1% rise in pre-tax profit to RM1.5 billion for its financial year ended Dec 31, 2007, on the back of a record gross income of RM616.9 million. Just recently, for the year 2008, the Lembaga Tabung Angkatan Tentera (Malaysian Armed Forces Fund) is rewarding its contributors with a 7% dividend, 3% bonus and 6% special bonus.

The total dividends and bonus for 2008 would be 16%, which was in line with 2007. The total amount would be RM597.9 million, up 8.3% from RM552.2 million a year ago. The superannuation fund said on March 13 that it recorded pre-tax profit of RM631.4 million for the year ended Dec 31 last year, a 2.3% increase from the RM616.9 million in 2007. LTAT said the pre-tax profit was the highest since the Asian financial crisis in 1997. It recorded pre-tax profit of RM697.6 million in 1996. Its total assets as at Dec 31 had increased by 8% to RM7.2 billion and the total contributions last year were RM4.8 billion from the 116,000 contributors.

To be fair, there is no way for EPF to even come close to LTAT's performance because the mandate is very different, and EPF is also very much hampered by its sheer size. Most of EPF funds are in bonds and that will anchor the performance a lot. Whereas LTAT is managing around RM5bn only.

We will get a better idea on LTAT by looking at their policies. From its website: On the investment front, it has always been LTAT's policy to adopt investment strategies whereby investments are spread out in as many sectors and industries as possible to ensure stability of returns in whatever type of economic environment, and to provide steady growth in investments in the long term.
As part of its long term strategy, LTAT has substantial investment in the plantation industry to take advantage of good prospects of the agricultural sector. LTAT has also taken up investments in property development and participated in companies involved in the manufacturing of building materials. To further enhance its income in property development, LTAT has entered into joint ventures with foreign and local investors to undertake industrial, residential and new township development.

In the financial services sector, LTAT has controlling interest in a number of financial institutions including a commercial bank, a merchant bank, a finance company, a general insurance company, a discount house, a money broking house, a stockbroking company and an asset management company.

In the medium and heavy industries sector, LTAT has acquired substantial interest in a number of prominent companies involved in steel milling, and the manufacture of industrial gas and electrical cables.LTAT also has interests in a number of companies in the transportation sector in particular those dealing in the assembling and distribution of motor vehicles and heavy equipment and the manufacture of automotive component parts. In the telecommunications industry, LTAT is involved in the supply and installation of fixed and mobile telecommunication equipment, exchanges and infrastructure network.

Under the superannuation scheme, serving members of the other ranks in the Armed Forces are required to contribute 10% of their monthly salary to LTAT with the government as employer contributing 15%. For officers, participation is voluntary and the contributions are a minimum of RM 25 with a maximum of RM750 monthly.

Looking at LTAT's portfolio, they include Asiatic, Boustead, Affin and BP. Like it or not, by sheer luck or good planning, almost every single exposure had a wonderful run over the last 4 years (yes, Affin had it difficult for a long time). Oil, plantations, property and financials - is it any wonder why they did not do well. Not to mention building materials as well. However all businesses are cyclical and they will not always be that good. There will come a time where these sectors will be on a down cycle, and we will see dividends of LTAT being pulled back to the mean. Still, they have manged to set very good returns over the last 4 years and deserve a pat on their backs.

But let's be clear here, LTAT had a good run, their portfolio were in the right sectors. If you run a business and the sector had a strong upcycle, was it due to you or to macro factors? You can buy and select the business, call it that you made the top-down macro view work for you.

I would be more severe on LTAT's performance before they start congratulating each other. I would do peer-to-peer reviews on their companies especially since most are controlled vehicles and long term core holdings. Boustead Plantations is no hero when it comes to yield management. Affin is no leader in finance, in fact most performance metrics would be pretty unimpressive. You can do that to each business. Yes, their performance was good, but if they had improved in each business segment to be in the top quartile for their sector, they would have been looking at maybe 20% return for each of the last 4 years!

Despite all of LTAT's strong performance, I WOULD BE VERY VERY CAUTIOUS with LTAT's asset allocation. Its very high risk, and the fund may even see drastic losses in future owing to their type of exposure. You don't get 20% returns year in year out, without a strong likelihood of losing 20% as well. Somebody should really go through LTAT's mandate and strategy and rework it while no untoward damage as been done YET.

This should never be compared to EPF, they don't have the flexibility to just invest in just a handful of stocks owing to their size. We all should be happy with 4.5% now. Even the 5%-6% in 2006 and 2007 during strong bull runs is very good. Its a pension fund, you NEVER want your pension fund to take up so much risks, i.e. in equities... or invests in unnecessary risks such as foreign currency bonds. As EPF will be managing ringgit funds for Malaysians, the end story is that it must manage a decent rate of return in ringgit. Putting 80% or more in local bond papers is OK and necessary. If EPF had put 50% in stocks, the fund may have declared 12% returns in 2007 but in 2008, we could have zero or worse, -10%. Pension funds must not lose money.

The only danger I see is that EPF is increasingly looking to be the lender of last resort for local bond papers. That is an unhealthy development no matter how you cut it. Bank Negara should look into this area to mitigate the future risk.

On a side note, the FAQs below should not have highlighted other big foreign funds as most are not pension funds but sovereign wealth funds (don't think people are stupid la...). Compare apples with apples, just do it with CPF would be fine.

The Employees Provident Fund has declared 4.5 per cent dividend for 2008, its lowest since 2003. It provided a list of questions and answers that accompanied its statement on the dividend yesterday.

QUESTION: Why is the EPF’s dividend for 2008 lower than that for 2007?

The EPF Board declared a dividend of 4.50 per cent for 2008. This dividend rate is lower compared to that of 2007 due to the increase in investment provisioning resulting from the sharp decline in global equity prices brought about by the worldwide financial crisis.

Although the EPF earned its highest ever gross income in 2008, the EPF has made provisions of RM4.69 billion for diminution in equity value after a sharp fall in equity prices as a consequence of the global financial crisis. This has significantly reduced our net earnings but this provision remains unrealised, as we have not sold off our shares. This provision will be written back once the equity markets recover.

Nonetheless, our dividend rate compares favourably with fixed-deposit rates offered by Malaysian banks. For instance, the current 12-month fixed-deposit rate for Malaysian banks is 2.50 per cent.Additionally, an increased amount is needed to pay 1 per cent dividend to members for 2008. For 2008, the EPF required RM3.18 billion to pay 1per cent dividend compared with only RM2.89 billion in 2007.

Q: Why was the provision made for 2008 much larger than 2007?

The provision written into our books for 2008 is RM4.69 billion, of which RM3.2 billion was allocated for overseas equities. This figure is much higher than the provision for equity diminution in value in 2007, which was only RM0.52 billion. This provision is made due to the sharp drop in equity markets especially in the fourth quarter of last year. However, we are confident that this provision will be written back once recovery takes place.

Despite this provision, equities remained as the second biggest contributor to the EPF’s total gross income bringing in RM6.67 billion in 2008 compared with RM5.37 billion in 2007.

It should be highlighted that the EPF compares better than many other funds around the world. For example:

# The government pension fund of Norway suffered a US$92 billion loss on its investments in 2008. (BBC News, March 11 2009);

# Temasek Holdings suffered S$58 billion paper loss in eight months. (Singapore BT, February 11 2009);

# Government of Singapore Investment Corporation Private Ltd asset value fell 25 per cent from its peak. (Bloomberg, March 5 2009);

# California Public Employees’ Retirement System (CalPERS) suffered a US$68 billion loss in assets since October 2007 and a 41 per cent slide in its stock portfolio. (Bloomberg, February 26 2009); and

# Khazanah Nasional Bhd suffered a loss of one fifth of its investment portfolio and its realisable asset value of RM88.2 billion as of May 31 was reduced to RM70.4 billion at the end of 2008. (BT, January 20 2009)

Q: What is the EPF’s forecast for 2009?

We are bracing ourselves for a tough year ahead as the effects of the financial crisis continue to be felt. We expect 2009 to be a very challenging year, and the expected dividend will therefore not be more than 2008.

Q: How did the EPF manage to offer a dividend of 8 per cent in the 80s?

In the 80s, EPF’s investments were concentrated on interest-based investments, such as Malaysian Government Securities (MGS). It should be noted that the interest rate regime during those years were high, with the average base lending rates (BLR) hitting a peak of 12.25 per cent in 1984, compared to the significantly lower current BLR.

Consequently, investments in MGS during that era were able to produce very high returns for the EPF, making it possible for the fund to declare its highest dividend rates. However, the high interest rate regime also meant that cost of housing loans and hire purchase were considerably higher at that time than they are now.

Q: How safe is my money in the EPF?

Your money is very safe in the EPF. As a retirement fund, we will continue to maintain a prudent and low-risk investment policy backed by thorough research and in accordance with investment best practices.

Furthermore, the EPF Act 1991 guarantees that the dividend rate will not fall below 2.5 per cent.

Q: Why are other savings funds in Malaysia able to offer better dividends than the EPF?

The simplest explanation is that other funds have different investment objectives. The EPF maintains an asset allocation structure that does not expose the investments to high risk in line with its role as a retirement fund. Other funds are also much smaller in size compared with the EPF which stands at RM340 billion.

p/s photos: Fala Chen


Gamelion said...

If EPF want to pay more than 8% dividend why dont they operate a sure made money casino ????

Trashed said...

Is LTAT's performance also predicated on the allocation of shares in IPOs ?

I may be wrong but I don't think the EPF gets IPO allocations.

Ramzi said...

Thanks for the great article.

I feel vindicated now working here.

EPF Investments personnel