How Malaysia’s EPF uses external managers

In an exclusive interview, Mohamad Nasir Ab Latif, deputy chief executive and a 34-year veteran of Malaysia's Employees Provident Fund, told AsianInvestor about the pension plan's allocation approach, how its investment team is set up and how it uses managers.

EPF is the country's largest retirement fund, with RM675 billion ($161 billion) under management. In terms of asset allocation, 51% of its portfolio money is in fixed income, with a large proportion in government securities and high-grade corporate bonds. It only buys investment-grade issues.

The fund currently has 44% in equities, of which 2% is private equity and the rest listed equities. Its alternatives allocation is 4%, including infrastructure and real estate, but it plans to at least double that to 8-10%, as reported. EPF avoids hedge funds and smart-beta strategies, the reason for which Nasir explains here.

This article is an extract from a longer feature that appeared in the May issue of AsianInvestor magazine.

AsianInvestor: What’s your split between in-house and outsourced investment?
Nasir: The majority of investments are done in-house; 14% overall is outsourced to external managers who are mandated to manage actively. We have indices we base our models on. We don’t totally hold to the benchmarks, but it is largely buy-and-hold, although as I said we do trade. 

Outsourced mandates are more active and we give external managers a higher tracking error. We have not appointed any quant managers so far; all our managers are fundamentally driven. 

They are given leeway to use their expertise, but there are stocks in sectors they are not allowed to buy. We are an ethical fund. We do not invest in [firms involved in] gambling, alcohol, military weapons or adult entertainment. 

How detailed is your in-house monitoring?
There is a constant monitoring of managers, to check on continuity. Our risk guys pay them a visit as part of the risk management programme. We also get performance analysis from our global custodian, BNY Mellon. We use Citibank for domestic custody. 

How has your international exposure evolved?
In 2006 we began investing in Asean, then North Asia, Europe and the US. Today our exposure in the listed space is balanced between emerging and developed markets.

But if you look at alternatives, this is largely focused on developed markets. We started out investing in the UK and Australia, and even now our weighting is still heavily in those countries. We are talking real assets, commercial buildings, shopping malls and logistics depots. 

We feel no need to have a hedge fund absolute-return kind of mandate, and they have not performed that well either over the last few years.

Do you use Malaysian fund managers?
There’s no point outsourcing to external managers in the Malaysian market because many of them are quite small and as a big investor you’d be crowding out the market. So while overall 14-15% is managed externally, in the equity space about 22%% is managed externally.

How does that break down?
For domestic equities the split is 90% managed internally and 10% externally; for foreign equities the split is 60:40 for internal versus external.

We use the FTSE Global index, MSCI Asia ex-Japan and FTSE Asean index, and internally we have a separate benchmark for Europe (FTSE Europe). We use the same index for internal or external managers. The only thing is how much risk you can take. Tracking error is tighter for us compared with external managers, who are given a 6% tracking error limit. 

How do you assess external managers?
Managers are reviewed on a three-year rolling basis. We are prepared to give them time, but there are cases where we have terminated managers. It’s good if they can explain why they have underperformed and what they’re doing about it. If something has gone grossly wrong, or if it becomes clear there is no one taking care of the portfolio, the right thing to do would be to fire them. 

We had one manager where we took the whole mandate back. They had people on the ground and we were not happy with what they were doing, so we closed it down. Otherwise, if the strategy has gone wrong and the manager is taking steps to rectify that, what we would do is penalise them a bit, taking a portion of the assets back or reducing their fees. 

Do you use consultants to help with portfolio construction?
The SAA is reviewed every three years, and on a quarterly basis we do a dynamic asset allocation review. We work with Mercer currently for advice on strategic asset allocation.

When we started we worked with Frank Russell, who helped us to build the initial manager selection. In the past we have worked with Towers Watson and we still use them for specific assignments, for example when we want an independent view of our manager roster. We have gradually taken that capability in-house, though.

Do you get involved in co-investment or club deals?
There’s a few ways we do it. We started out using private equity funds of funds. Then we moved into individual funds and from there we took the step of co-investing, at least outside of Malaysia.

EPF has been a direct investor in many of the largest infrastructure projects in Malaysia. We do have networking with other big funds, so we get involved in club deals. We are now looking more closely at natural resources. We have some allocations. It could be forestry, farming or other natural resources. We haven’t put anything there yet, but we are looking and talking to fund managers.