Wednesday, September 21, 2016

Personal Wealth, The Edge Malaysia Weekly Cover Story: Lower for longer II

This article first appeared in Personal Wealth, The Edge Malaysia Weekly, on September 12 - 18, 2016. 

Retirement planning to get tougher
BlackRock Inc’s global chief investment strategist Richard Turnill said in a Bloomberg report in late July that it is going to be really hard for any asset class to give investors returns of more than 6% in the coming years.

“Most won’t even scrape 5%. Our five-year return assumptions have steadily moved lower since the financial crisis, amid weak global growth prospects, easy monetary policy and rising valuations. We have lowered our assumed returns for most fixed-income assets, following a drop in yields (and rise in valuations) in the second quarter,” he added.

According to Schroders’ Seven-Year Asset Class Forecast Returns: 2016 Update, Asia-Pacific ex-Japan equities will generally be the best performer in the 2016  to 2023 period, with real returns forecast at 8.5%. This is followed closely by Japanese equities, with real returns of 7.9%. UK equities will be the worst performer, delivering real returns of -2.1%. Private equities will do well and is predicted to generate a 7.5% real return (see table).

The low-growth, low-return environment will make it much tougher for those heading for retirement. In McKinsey Global Institute’s Diminishing Returns: Why Investors May Need to Lower Their Expectations, released in May, it was found that lower rates of return could have a profound effect on both individual and institutional investors, and by extension, on governments as well. For example, a 2% difference in average annual returns over an extended period means that a 30-year-old today would have to work seven years longer or almost double her savings to live as well in retirement.
“As a result, pension funds could face a funding gap that is even larger than the one they are struggling with today. Among others likely to be affected are asset managers, whose fees will come under pressure in a lengthy period of lower returns, and insurers that rely on investment income for earnings … policymakers may need to prepare for a later generation of retirees with less income,” says the report.

As it is, one’s retirement savings are usually not enough. In May, EPF’s head of strategy management Balqais Yusoff pointed out more than two-thirds of its contributors (78%) did not have at least RM196,800 to sustain them in their retirement years.

As pensions are going to be affected, those who are preparing for retirement today have to make serious adjustments to their lifestyle or savings, says Wan Kamaruzaman. “We are trying to educate civil servants on the importance of financial planning when they enter the labour market. Financial planning starts the moment you start working.

“Previously, we focused more on people nearer the retirement age. But now, it is the other way around. We are trying to inculcate a saving culture to remind us that we need to save more to retire.”
He acknowledges that it is not going to be easy. “It is a Catch 22 situation — you tell people they have to save more, but the cost of living and discretionary spending mean they do not have enough to save. Companies are not performing that well, so obviously, the bonuses will not be as great. It is a vicious cycle.”

Datuk Javern Lim, group managing director of VKA Wealth Planners Sdn Bhd, advises people to focus on increasing their monthly income so as to be able to save more. “Focus on increasing your monthly income stream, which can lead you to save a bigger 10% portion for investment too. Consider some structured investment products that may require a longer lock-in period but are able to offer a higher return on investment.”

In an investing climate like this, investors may be tempted to invest in higher risk assets to compensate for the lower returns from other assets. But Yong Chu Eu, licensed financial adviser at Fin Freedom Sdn Bhd, advises against it. He does not recommend taking higher risks in today’s climate as investors risk losing all of their money.

“High living costs are pushing more people to more complex, short-term, high-return investment schemes so that they can have their retirement on track or financial freedom soon, which I don’t think is appropriate. Because of this, many people end up losing money after falling into investment traps or scams, or taking on too high a risk,” he says.

Lim advises investors to stay away from investments that could see them lose all of their money. “When we invest in unit trusts, we invest in businesses. When we invest in properties, in the worst-case scenario, the properties are still there. The same goes for gold; the gold bars are still there. We are talking about accumulating a retirement fund for our old age. Our retirement fund is serious money. We cannot afford to lose it,” he says.

Picking an investment that offers tax benefits is all the more important in this climate. Lim says investors should consider instruments that could offer moderate returns and yet free you from tax implications. PRS is a case in point.

“[If you are in a high tax bracket,] you have already saved 25% in tax on that RM3,000 invested, that is, assuming the RM3,000 did not give you any returns. Moreover, the PRS funds are managed by the fund managers who also manage the existing funds [into which many of the PRS funds feed].
“Under the regulations, they can only charge up to 3%, so there is an immediate saving of 2%. Some even charge a 0% fee.”

De Alwis advises investors to reexamine their portfolio. “If everybody is chasing returns, now is the time to look again at your portfolio to ensure that you really have diversification across the different investment classes. Bear in mind, I don’t mean asset classes, but investment classes,” he says.
“When I say asset classes, many get confused because they begin thinking how much they should put into equity, fixed income and balanced funds. When I say investment classes, it is a good time for you to look again at things on a holistic level — how much exposure you have in unit trusts, the stock market, properties, bonds and so on.”

Today, it is even more important for investors to set a “true blue minimum target”, he says. “When I ask investors, they tend to say 8% or 10%. But your true blue minimum target should be your real inflation rate, which should be averaged at 3% to 4%.

“You can be more ambitious and give yourself 5%. But first things first. You have to build a portfolio to make sure you can achieve that minimum 5%. From there, you need to remember that you have certain things that give you higher returns over a certain period.

“You have to look at the annual returns of your portfolio. Start looking at those that give you higher returns over a rolling period [when returns and markets] are higher, and those during years that are lower.”

Investors must revisit their retirement portfolio and set realistic targets. De Alwis says with a floor target, their mindsets change and they find that they do not need to take on much risk to achieve their targets.

“If I were your financial adviser, I cannot build your portfolio around 8% [which is your ideal target]. I need to set a minimum floor of 5%. After that, we ask how do you achieve more than 5%?
“Let’s say you want 8%. If you use the rule of 72, you will need nine years [to double your initial investment]. But if you take 72 and divide by 5%, it will take about 12 years. Is that acceptable or do you need to put more money in? Do you need to save more? Then the reality sets in.
“So, I always ask people to take a few steps back. I am not saying you should put everything into less risky assets. But once you take a few steps back, you would have better peace of mind. I have already conservatively decided that I need 5% and I have 12 years to [double my investments], so that means I will be fine.

“It is a fact that the low-yield environment is here to stay. So, manage your expectations and revisit your portfolio; whatever extra is a bonus. Be more pragmatic about your financial planning — diversify properly across all investment classes.”

Investors must always have cash ready to deploy to take advantage of future opportunities and to average down. “These two strategies are different because averaging down means doing it when the market is down. You do not want to be forced to realise your loss. Opportunity means when you see a potentially good investment coming and you don’t want to sell down [your other investments], you have the cash. Now is a good time to revisit your portfolio because there are always opportunities when the market is down.

De Alwis elaborates further on portfolio allocation. “In your portfolio, 20% should be as liquid as possible because the first rule of thumb of liquidity when you invest is you need to know how much your reserve can last you.

“Before you invest in anything, make sure you have a cash reserve of three to six months. That is the basic principle. Once you have the reserve, you can invest the additional portion. Of that portion, I recommend putting 20% in liquid assets.

“You never know when an investment opportunity is coming and you want to catch the trend without have to sell any of your current holdings as it is just a short opportunity that you can liquiditate later. Do not have an investment portfolio that gives you no choice but to realise your losses unnecessarily.”

Options for EPF contributors
Contributors to the Employees Provident Fund (EPF) have a few options if the dividend is low. Yong Chu Eu, a licensed financial adviser at Fin Freedom Sdn Bhd, says they can use their EPF savings to pare down debts such as their mortgages or withdraw more to put into unit trusts.
“They can use their EPF savings to offset debts, especially housing loans. If interest rates fall to a similar rate as the housing loan, the free cash can be used to invest.

“Let’s say your current effective interest rate for the housing loan is about 4.5%. If EPF dividends fall below 5%, then it is wise to withdraw your EPF money to pay monthly loan instalments for a year, which will give you free cash to invest. This way, you are managing your ‘good debt’ to grow your wealth.

“They can also withdraw some of the EPF money [quarterly] to invest in approved unit trusts to get more returns. The EPF investment strategy is very conservative. If you look at its previous annual reports, most of its money are invested in bonds and the guaranteed annual return is 2.5% (the average return over the past 64 years has been about 5.9%).

“That might not match the risk appetite of someone who is hungry for higher returns or looking for more risk (more equity/foreign exposure) ... If we refer to Fundsupermart’s fund ranking (last updated Aug 20), Kenanga Growth Fund is the top performer with an average 17.2% return yearly for the past 10 years (about around 17% annualised return for the past 15 years). This fund’s returns are far more superior than those of EPF and unit trusts.”

Those who have cash to spare can place their savings in private mandates under the EPF-approved investment scheme. A quick check found that PhillipCapital is a provider of the private mandate option.

“Investors can withdraw their money from Account 1 and pass it to the EPF-approved fund managers who will select stocks for them. The minimum investment is RM30,000, so this option is only for investors who are willing to take higher risks in exchange for possibly higher returns,” says Datuk Javern Lim, group managing director of VKA Wealth Planners Sdn Bhd.

Personal Wealth, The Edge Malaysia Weekly Cover Story: Lower for longer I

This article first appeared in Personal Wealth, The Edge Malaysia Weekly, on September 12 - 18, 2016.

Pension funds are beginning to see lower returns from their investments and have warned that this could continue for some time. Hence, contributors will be forced to rethink their retirement planning strategies.

A prolonged period of low growth and low returns from investments is beginning to affect pension funds around the world. Soon, their contributors will be faced with a stark new reality and will have to re-evaluate their retirement plans as they dig deeper into their savings to fund their golden years.

Pension funds are acknowledging the tough investing landscape and are beginning to manage the expectations of their contributors. Numerous experts have pointed out that double-digit returns from assets are a thing of the past and single-digit returns are what we can expect going forward.
The Employees Provident Fund (EPF), which has provided an annual dividend of 6% and above since 2011, has warned that it will not be able to maintain the rate this year as its investment income for the first quarter ended March had declined 36.21% year on year to RM6.78 billion.
At the results announcement, EPF CEO Datuk Shahril Ridza Ridzuan said the fund was bracing for a difficult year, given the uncertainties in the global economy following prolonged slow growth in the major economies and high volatility in the equity and commodity markets. EPF had 14.55 million members as at December last year.

Kumpulan Wang Persaraan Diperbadankan (KWAP), a pension fund for civil servants, has also been going through trying times. CEO Datuk Wan Kamaruzaman Wan Ahmad says the biggest challenge for pension funds is obtaining the desired returns.

“For that reason, we need to lower expectations. The trouble is we are used to the 6% or more returns of the last decade and since the fund’s inception. But the reality is that getting anything beyond 5% is very difficult at this point in time. Based on where the interest rates, dividend yields and corporate performances are currently, we think 4.5% is a more achievable figure,” he tells Personal Wealth in a recent interview.

Wan Kamaruzaman says the pension fund had seen an average return of 6% a year. The downtrend began last year.

“We did not do that well last year, especially on the equities side. We had negative returns from local equities. So [our portfolio] only returned about 5.4%.

“The bond market has done reasonably well, but the reality is that the market is a double-edged sword. You do well after the overnight policy rate (OPR) cut, but your reinvestments are all at lower levels after that, [and this drives your] portfolio returns downwards.” Last year’s gross investment return of 5.4% was below the 6.15% to 7.07% range for the previous five years.

Pension funds rely on formulas that depend on interest rate movements to determine their assets and liabilities. When rates fall, investment returns are impacted negatively. As a result, their obligations to future retirees balloon.

While lower bond rates enhance the value of existing holdings, pension funds record losses when the bonds with bigger payouts purchased many years ago reach maturity and are replaced with lower-yielding investments.

Wan Kamaruzaman says there are very few signs that the “lower for longer” environment will turn around soon. Instead, we can expect this scenario for the next three to five years.
“In the US, they cut rates to almost zero in 2008/09, and it has remained about the same until today. They recently raised it by 25 basis points, and that was after almost eight years. Europe just started lowering rates, and has gone into negative territory. In Japan, it has been there for much longer,” he points out.

Wan Kamaruzaman says the downtrend is just beginning and will soon translate into lower dividend payouts for investors and contributors. “The 3% OPR level is not too bad, compared with the rates in the developed world. In addition, you cannot get the kind of returns you get from Malaysia’s bond market in the more mature bond markets like South Korea, Hong Kong or Singapore. So, we are quite happy we are getting over 3% from the government bonds and about 4% to 5% from corporate bonds. If they go lower, it will be a challenge.

“[When referring to returns in the next few years], we are looking things trending down and staying low. It is actually a ‘U’ rather than a ‘V’-shaped graph, or more accurately, a prolonged ‘U’.
“In terms of dividend payments to investors and contributors, the downtrend is just beginning, so people have not really felt it. Returns can only go further down before they go up in the ‘lower for longer’ scenario. So, contributors will have to get used to this trend.”

EPF and KWAP are not the only retirement funds grappling with the problem. On Aug 26, Japan’s Government Investment Pension Fund reported a loss of 3.9% or ¥5.2 trillion (RM211.9 billion) for the April to June quarter. The world’s largest pension fund partly attributed it to the rise of the yen after the Brexit vote and poor US unemployment data in May.

The returns of the government pension fund are a huge concern since more than a quarter of Japan’s population are age 65 and above. The loss is similar to the US$50 billion investment losses attributed to the strengthening of the yen and fall in Tokyo stocks owing to the global market turmoil.
The US’ second largest pension fund announced at end-July that it made a return of just 0.61% for its fiscal year ended June 30, its worst performance since 2009. Investment managers at the California Public Employees’ Retirement System attributed it to the challenging low-return environment. Until last year, the fund had had an average annual return of 7.8% over the last 20 years.

On Sept 1, The Telegraph reported that British firms’ defined benefit pension scheme deficits spiralled by another £100 billion in the previous month alone as record low interest rates sent liabilities through the roof.

UK plc’s total deficit now stands at £710 billion, its highest ever, according to PwC’s Skyval Index.
The Canada Pension Plan Investment Board fared better, recording a net investment return of 1.45% for the three months ended June 30. While this was positive in the light of the Brexit vote, it was still well below the returns seen over the past 10 years.

“The fund’s 10-year rate of return in the first quarter was 5.5% after accounting for inflation, down from 5.8% in last year’s corresponding quarter. The 10-year real rate of return remains above the Chief Actuary of Canada’s benchmark of 4% annualised real rate of return,” it was quoted as saying.
Earlier this year, it was reported that the average pension fund in Australia, Canada, Japan, the Netherlands, the UK and the US all produced lower investment returns than in 2014.

In late May, The Wall Street Journal reported that pension funds and other large endowment funds were heading deeper into riskier investments to get the desired returns. Many have begun investing in global stocks, real estate and private equity investments, instead of the usual high-grade bonds.
According to a study by investment consultancy firm Callan Associates, which advises large investors, this is a stark contrast to two decades ago when returns were easier to come by. The study found that a portfolio made up of only bonds in 1995 would return 7.5% a year, with a likelihood that returns could vary by about 6%. To achieve that same return in 2015, it said investors would need to spread their investments across risky assets and shrink their bond holdings to just 12% of their portfolio.

The study noted that private equity investments and stocks needed to make up three-quarters of the entire portfolio. But with the added risk, returns could vary by more than 17%.
Wan Kamaruzaman says contributors would have to lower their expectations in terms of the returns they will get as pension funds are unable to increase their risk exposure exponentially. “There are many ways to invest and get higher returns. But for a pension fund, it is about its risk appetite, and ours is a conservative one. We do not want to compromise on our risk appetite. That is why we cannot take on too much risk by investing in asset classes with a high-risk, high-return profile.”
Nevertheless, KWAP has diversified a portion of its assets into alternative investments over the years. “At the moment, almost 90% of our asset allocation is in equities (30%) and fixed income (about 54%). The rest are in private equity (2%), real estate (4%) and cash. We keep cash even though we do not have any liabilities as it allows us to be a bit more opportunistic. We can use cash when there is volatility in the market,” says Wan Kamaruzaman.

An EPF spokesman says in an email statement that while the provident fund does not usually comment on market movements, the current economic condition presents some opportunities for it to rebalance portfolios and increase exposure to asset classes such as real estate and infrastructure that potentially could provide a stable stream of income.

“As for managing expectations, our investments have always emphasised sustainability of returns over a long-term horizon as opposed to short-term gains. More importantly is that we are able to meet our two strategic investment targets — at least 2.5% nominal dividend on a yearly basis, as required by the EPF Act 1991, and at least 2% real dividend on a rolling three-year basis,” says the spokesman.

Over the years, EPF has increased its exposure to overseas assets, which has helped offset some of its losses from local investments. It has also invested about 5% of its portfolio in alternative investments such as private equity.

Unit trust fund managers have also been managing investors’ expectations. Ismitz Matthew De Alwis, executive director and CEO of Kenanga Investors Bhd, says investors should expect returns of 8% and above for equity funds, 5% to 6% for balanced funds and 4% to 5% for bond funds. These are net of fees (except for the upfront sales charge).

“The net returns on balanced funds are so close to bond funds because the latter charge a lower fee. Generally, these returns are what we are targeting. In any investment, you should target at least 2% above your risk-free rate,” he adds.

Ho Seng Yee, CEO of RHB Asset Management Sdn Bhd, says investors should expect between 4% and 12% on all types of funds when averaged over a longer period. “If you are looking at 3 to 5 years, you should have 8% to 12% for equity funds, 4% to 6% for fixed income and 6% to 8% for balanced funds. These are returns from asset classes over the longer term, so investors would have this range of returns if they stay invested longer.

“A good fund manager should be able to beat the market. We need to educate investors not to expect 12% or 15% returns at least for the next two to three years. You have to live with a lower return environment.”

Kenanga Investors and RHB Asset Management are among the EPF-approved fund managers and providers of the Private Retirement Scheme (PRS), a voluntary long-term investment scheme aimed at helping people save for retirement.

Aggressive PRS funds saw returns of -1.25% to 4.3% for the 12 months ended July 31 while moderate funds delivered returns of -3.24% to 5%. For conservative funds, returns ranged between 2.45% and 4.57%.

Some non-core funds outperformed the core funds. In particular, AmPRS – Asia Pacific REITs D and I returned 22.19% over a one-year period while AmPRS – Tactical Bond D and I returned 10.17%


Tuesday, September 20, 2016


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