By Mushtak Parker
Public pension funds (PPFs) impact individuals, society and the economy in many crucial ways.
They provide financial security to millions of participants when they retire, thus contributing to societal stability and cohesion, and contribute to the economy through their investment portfolios.
PPFs worldwide are at a crossroads caught in recent times in the eye of the COVID-19 pandemic storm but are at the same time at the crest of new investment and strategy possibilities especially in infrastructure and the United Nation’s ESG, SDG, climate action and sustainability agenda, effectively leading the global economy into new directions.
PPF asset allocation strategies are fraught with political sensitivities especially when investment returns are below par and when governments are tempted to force such funds to part invest in economic sectors such as infrastructure, state-owned utilities and government-linked companies (GLCs).
Which some critics stress could threaten the very retirement security of ordinary people especially if some of the investments are deemed risky and in entities prone to overspending, mismanagement, and corruption.
As such, the Global Public Pensions 2020 Report published last week by London-based Official Monetary and Financial Institutions Forum (OMFIF), an independent think tank for central banking, in conjunction with Citigroup and Capital Group, could not be more timely and opportune.
“With more than US$17 trillion in investable assets,” explains David Marsh, Chairman of OMFIF, “public pension funds are a crucial investor group, larger than sovereign funds and central banks. But their importance extends beyond financial clout.
They lie at the heart of profound changes and trends in global finance, in demographics, geopolitics and technology,”
The asset allocation decisions of global pension funds relating to differing asset classes, actuarial targets, new conceptions of fiduciary responsibility and changing populations and evolving demographics, he maintains “will play a critical part in the post-pandemic global recovery.”
One area in particular where PPFs have a potential game-changing role consistent with intensified global interest is in investment geared to environmental, social and governance considerations – the pending new economy.
There is simply no alternative to elevating ESG to the highest level of investment strategy.
Public funds, benefiting from a longer-term outlook and backed by state power, can take the initiative, adds Marsh. A sentiment with which Tunku Alizakri Raja Muhammad Alias, chief executive officer of the Employees Provident Fund (EPF), Malaysia’s public pension fund, strongly agrees. EPF’s asset allocation strategy over the last decade or so has indeed featured increasing forays into ESG and sustainability investments.
“ESG is not a “nice-to-have”, it’s a definite “need-to-have”,” stressed Tunku Alias in the OMFIF Report.
“We know that good ESG practice is the best barometer for companies that are well run. If you practise ESG well, your company is on the right trajectory to succeed. In making investment decisions, we strongly favour companies that focus on sustainable returns and also actively manage the ESG impact of their businesses. These are the types of enterprises and assets that we want as part of the EPF portfolio in order to achieve our vision of helping create a better world for all.”
In fact, at the time of writing, one of the largest pension funds in the world, Japan’s Government Pension Investment Fund (GPIF), announced a combined US$12 billion investment in two ESG equity indices – comprising approximately US$9.7 billion to MSCI’s ACWI ESG Universal Index and US$2.9 billion to Morningstar’s Gender Diversity Index.
In supporting the post-pandemic recovery, global public investors have a chance to build on the momentum of this sustainability agenda of the past years.
However, they still face significant barriers in scaling up these efforts.
To put the investment power of PPFs including that of Malaysia’s two public pension funds in context, the top 100 largest public pension funds (PPFs) in the world, according to the Las Vegas-based Sovereign Wealth Fund (SWF) Institute’s latest rankings, manage aggregate assets totalling a staggering US$17.762 trillion.
The list is dominated by North American and Asian public pension funds – two regions where pension provision density is the highest.
With current assets under management (AUM) in excess of US$201 billion, Malaysia’s EPF ranks a credible 19th position, albeit way behind the two largest, the Baltimore-based US Social Security Fund at US$2.91 trillion followed by the GPIF Japan with an AUM totalling US$1.59 trillion.
Employees Provident Fund
EPF is one of the oldest retirement funds in the world, established in 1951 essentially as “a social-security organisation focused on safeguarding member savings and delivering excellent services encompassing a comprehensive social well-being ecosystem.
Malaysia’s smaller PPF, Kumpulan Wang Persaraan (KWAP) founded in 2007, is ranked 93rd with current assets totalling U$34.67 billion.
These figures do not include, amongst others, private pension, retirement and annuity funds, and the investment assets of Sovereign Wealth Funds (SWFs), which are state-owned investment funds or entities which are commonly based on balance of payments and fiscal surpluses, proceeds of privatisations and receipts resulting from resource exports. Malaysia’s SWF or GLC, as it is known, Khazanah Nasional has current AUM of US$20.2 billion and is ranked as the 35th largest one in the world in SWF Institute rankings.
The total AUM of the 92 largest SWFs at December 2020, according to the rankings, amounted to US$7.95 trillion, dominated by mainland and diaspora Chinese and Arab Gulf SWFs.
The standout exception is the single largest SWF of them all, the Norway Government Pension Fund Global with AUM of US$1.122 trillion followed by the China Investment Corporation with current assets of US$1.05 trillion.
The reality is that public pension funds worldwide have been affected by the COVID-19 pandemic through several ways in all their business operations.
According to the OMFIF Report, PPFs have been buffeted by swings in asset valuations generated by the sharpest downturn since the 1930s depression.
They have been driven into riskier portfolio allocations because of the much lower (sometimes negative) fixed-income returns caused by central banks’ quantitative easing.
Their funding base and liquidity have faced pressures from rises in unemployment and mitigation payouts such as furloughing in the UK for instance, but in a wider context reflecting varying repercussions on workforces and retirees in different countries.
Perhaps ironically, as a result of the massive fiscal and monetary stimulus packages unleashed by governments all over the world, including Malaysia, PPFs could be faced with long-dormant inflation in coming years.
PPF asset allocation strategies have been steadily shifting from traditional investment classes such as equities and sovereign bonds, with “the average pension portfolio now holding over 13% of its assets in real estate, infrastructure and private equity.”
The rationale is that PPFs can lead the investment revolution towards ESG and climate-related asset allocation especially in infrastructure to promote their new sustainability agenda and capitalising on a low-interest rate environment and low returns in the bond markets.
Albeit, the opacity, illiquidity and reputational dangers inherent in markets pose risks to pension funds.
Malaysia’s sizeable pension assets – US$235.67 billion in total, its flexible exchange rates, good access to forex, quality and transparent data, have ensured that it is in a stronger position to weather crises better and be more resilient. This despite the recent downgrade by Fitch Ratings of Malaysia’s sovereign rating by one notch from ‘A-’ to ‘BBB+’.
The IMF acknowledges that the “Malaysian authorities responded swiftly to the COVID-19 crisis, with material relief measures for affected individuals and businesses.
Nevertheless, the impact on Malaysia’s economy has been substantial, and has added to Malaysia’s fiscal burden, which was already high relative to peers going into the health crisis.”
The IMF projects the global economy to contract by 4.4% in 2020 and global trade by 10.4% – making 2020 the worst economic crisis since the Great Depression.
The Malaysian economy is projected by Finance Minister Tengku Datuk Seri Zafrul Tengku Abdul Aziz to contract by 4.5% in 2020, but with GDP growth projected to recover to between 6.5% – 7.5% in 2021.
The connectivity between governments and PPFs is entrenched.
The connectivity between policies relating to prescribed assets and PPFs is controversial and contentious, and often misunderstood.
Prescribed assets is a policy that enables governments to dictate to pension funds where they must invest a portion of the funds and savings of their members.
In South Africa, for instance, there is currently a heated debate on prescribed assets.
Critics talk about the government “forcing” the financial industry to buy government-backed bonds and equities using savings of clients, including pension funds, life insurance firms and individual investors primarily to plug budget funding gaps, COVID-related expenditures, inefficient GLCs and infrastructure.
Others see it as a policy that enables the government to dictate to pension funds where they must invest a portion of the funds and savings of their members.
Experiences the world over has shown prescribed assets to be inefficient and ineffective, especially in far lower return for investors than equities, which means that if such a policy is implemented, savers will be worse off when they retire.
However, there is a big difference between governments imposing prescribed assets as opposed to persuading PPFs to investing in infrastructure.
On the demand side, Putrajaya and EPF have introduced measures to help EPF contributors by reducing the minimum employee EPF contribution rate from 11% to 9% beginning January 2021 for a period of 12 months to increase take-home pay.
EPF introduced in April 2020 the i-Lestari withdrawal facility which allowed members to withdraw RM500 a month for 12 months with a total of up to RM6,000.
This facility has benefitted 4.7 million members with a total value of RM11.6 billion.
On the supply side, the importance of pension funds as drivers in addition to government requirements of the asset management industry could not be better illustrated by the investment-strategy EPF.
In June this year, EPF announced that a total of RM132.41 billion had been outsourced to external fund managers in 2019, an increase of 12.63 per cent compared with RM117.56 billion at the end of 2018.
This allocation, invested across both equity and fixed-income instruments, represented 14.12 per cent of the EPF’s total investment assets.
The EPF has two pension plan options – Simpanan Konvensional and the Syariah-compliant Simpanan Syariah.
In 2019, EPF delivered a dividend rate of 5.45% with a payout amounting to RM41.68 billion for Simpanan Konvensional, while Simpanan Syariah saw a dividend rate of 5% with a payout amounting to RM4.14 billion.
Under its investment strategy, some 40% of EPF assets are earmarked for investing under Syariah principles.
In September 2020, EPF reported gross investment income of RM15.12 billion for Q2 2020.
This despite, according to CEO Alizakri, the ongoing extremely volatile and challenging global economic and conditions.
EPF’s Strategic Asset Allocation (SAA) allocates 51% to Fixed Income instruments, 36% to Equities, 10% to Real Estate and Infrastructure and 3% to Money Market instruments “as a framework to optimise its long-term returns within tolerable risk limits”.
To its credit, the strategy has proven to be resilient in the face of COVID-19 with its overseas diversification contributing to its overall performance.
As at end-June 2020, the EPF’s investment assets stood at RM929.64 billion, of which 30% was invested in overseas investments.
The challenge for EPF as one of the best-run public pension funds in the world is the sustainability “of investing in fundamentally strong assets, especially those companies which have shown an ability to pivot in adapting to the new norm.”
However, there needs to be greater disclosure and/or clarity in EPF investment in GLCs and prescribed assets especially in Malaysia’s continuing infrastructure spend.
The good news is EPF’s strong commitment, in the words of CEO Alizakri and in line with the projections in OMFIF’s Public Pension Fund 2020 Report, “to accelerating the adoption of ESG criteria as a core part of our investment decision-making process.
In light of increasing uncertainties and volatilities becoming a norm, strong ESG practices will become a requirement as we believe that it will enable economies, industries and companies to be more adaptable and resilient in times of crisis.” — BERNAMA
- Mushtak Parker is a London-based independent economist and writer.