Malaysia's EPF boosting alts, cash for shelter from troublesome times

Malaysia's largest retirement fund is raising allocations to alternatives and cash to better navigate a gathering storm of economic and political challenges.

Mohamad-Nasir Ab. Latif, deputy CEO of Malaysia's Employees Provident Fund, said the 689.7 billion ringgit ($166.7 billion) Kuala Lumpur-based plan will likely hike its 10% target to real estate, infrastructure and private equity in pursuit of steady long-term returns in a challenging market environment.

On the tactical front, Mr. Mohamad-Nasir, in a Sept. 26 interview, said his investment team boosted the EPF's cash holdings in the first half of 2016 in anticipation of heightened volatility that could leave equity markets around the globe giving back some of their strong gains of recent years.

More than 10% of the EPF's allocation to public equities, which accounted for 41% of the fund's portfolio as of June 30, is in cash now. That's way above the typical level of 5% in recent years, the EPF executive said.

Even as a long-term investor, in the current market environment where equities remain relatively attractive compared to bonds while volatility is becoming more pronounced, the EPF “can't just sit there,” said Mr. Mohamad-Nasir. With the uncertainties haunting markets now, from the continued Brexit fallout to the timing of the Federal Reserve's resumption of interest rate hikes, “if there's any sharp fall” in equity markets globally, “we're in a position to take advantage” of opportunities, he added.

For the near term, the EPF's cash stockpile could rise further if Republican nominee Donald J. Trump looks set to win the U.S. presidential election, the EPF executive said. Given campaign statements that have raised the specter of protectionism and a U.S. move toward isolationism, markets could well retreat if Mr. Trump appears to take a commanding lead before the election, making it the better part of valor to “take profits and wait and see what happens after that,” said Mr. Mohamad-Nasir.

Amid those uncertainties, the EPF sold profitable equity positions in the first quarter of 2016 and has continued that course as equity markets pushed higher in recent months, said Lim Tze Seong, head of the EPF investment division's international equity department, in the same interview.

For the defined contribution backbone of Malaysia's retirement system, taking profits on some of the portfolio's strongest-performing holdings is central to the EPF's ability to annually credit a dividend to the system's 14.6 million members — perhaps the country's most closely followed financial announcement.

On Feb. 20, the EPF credited member accounts with a 6.4% dividend payout for 2015, down from 6.75% the year before but still the second-highest since 2000.

Under the rules governing the EPF, the fund cannot pay out anything from unrealized gains. “We need to sell and book in the profits in order for us to pay our dividend,” and every year targets are set for each asset class to achieve “a number that is doable,” said Mr. Mohamad-Nasir.

This year, with the investment team anticipating challenging market conditions, the EPF moved early to lock in those gains, said Mr. Mohamad-Nasir. Under normal circumstances, a lot of that money would have been rotated into markets with less demanding valuations, but “this time around we didn't put back much,” opting to hold cash instead, he added.

At a May news conference, Shahril Ridza Ridzuan, the EPF's CEO, said despite a difficult start to the year, he remained hopeful the fund could achieve its real-return target of 2 percentage points above inflation.

In the Sept. 26 interview, Mr. Mohamad-Nasir said an accelerating shift into alternatives will be a key to the EPF's efforts to reposition the fund for unforgiving markets in coming years.

The latest triennial review of the EPF's strategic asset allocation, due to be completed by December, will likely raise the current 10% target for real estate, infrastructure and private equity put in place three years ago for the period between 2014 through 2016, he said.

The fund remains well below that current target, with just more than 5% of its portfolio in those alternative segments. Even so, the “nice steady returns” the EPF's existing allocations are delivering have convinced the fund's leadership that it makes sense to narrow the gap with global pension counterparts in countries such as Canada and Australia, where alternatives often account for 30% of portfolios, he said.

High valuations in markets such as Australia and regulatory concerns about foreign-exchange volatility have slowed the growth of those investments at times over the past year, said Mr. Mohamad-Nasir. Malaysia's ringgit, which currently trades for around 4.13 to the dollar, fell to as low as 4.50 in 2015. And a year ago, Prime Minister Najib Razak called on the country's government-linked investment companies to take profits on successful overseas investments and reinvest the proceeds back home to boost Malaysia's economy.

Mr. Mohamad-Nasir said the EPF has never faced pressure to cut back on foreign allocations, which currently stand at 25% of its portfolio.

While there were times in 2015 when the process of getting necessary approvals for hefty overseas investments became more challenging, Mr. Mohamad-Nasir said for the current year, with foreign-exchange market volatility receding, he's been “quite happy” with the regulatory approvals EPF has been able to get for a wide range of overseas investments.

Private equity is one area that's seeing more activity. The EPF's allocations to private equity stood at 10.7 billion ringgit as of June 30, up 34% from the end of 2015. And the fund's 7.97 billion ringgit in private equity allocations at the end of 2015 was up 29% from the year before. Roughly 85% of those private equity allocations are invested overseas.

Mr. Mohamad-Nasir said allocations have shifted from an initial focus on private equity funds of funds a decade ago to individual managers now. And with the EPF's opening of a London office in October 2014, the fund's focus has further shifted to smaller individual funds of $1 billion or less, as well as dedicating more money to co-investments alongside private equity general partners, he said.

Still, “everybody is chasing yields” today, which has pushed the EPF to the sidelines in some markets such as Australia, where “we've slowed down quite a bit,” said the deputy CEO.

In spite of that fevered environment for alternative investments globally, Mr. Mohamad-Nasir said the EPF still sees interesting opportunities in real estate, which he called “our focus” now. In markets such as Japan and Germany, where financing costs are low, there are still opportunities to use leverage to obtain a return of 7% to 8% — “decent for a pension fund like us,” he said. n