Malaysia’s RM520 billion ($170 billion) Employees’ Provident Fund invests 85% of its assets domestically, where high interest rates and good equity performance has traditionally enabled it to meet annual return targets easily.

That has changed now that the country has become a favourite destination of global capital, thanks to the 3.5% yield on 10-year government bonds. Southeast Asia’s return to popularity has come at the price of EPF’s ability to achieve the 6% total returns it enjoyed last year.

Foreigners aren’t the only challenge: the introduction of private retirement schemes has introduced another source of demand for Malaysian securities. Together these have created a new dynamic: acute demand for local bonds.

“Previously, foreign investors focused on Malaysian equities, but now they are buying bonds too,” says Wan Kamaruzaman bin Wan Ahmad, general manager of the EPF’s treasury department, which is responsible for RM170 billion ($56 billion) of the portfolio, speaking at a recent AsianInvestor conference in Singapore.

“We’re competing to invest in bonds, and all this competition just depresses interest rates lower. So it’s a struggle to meet our payment promises.”

The EPF has seen private pension schemes launch all sorts of products that look fancy but can be confusing. The EPF is relying on its track record back to the 1950s of delivering its promised benefits on time to retain members. The EPF traditionally pays a high dividend. “But we can’t rest on our laurels,” Wan Kamaruzaman says.

Today the EPF has approved a 15% international allocation; earlier this year it completed a $1 billion global fixed income mandate. Getting the first such mandate done was hard; now further increases are a matter of market timing (it is thinking that equity valuations look attractive), and the EPF will take its time. Gradually its overseas exposure will climb to 20% or more.

Global investments do bring new challenges. “Regulatory changes are a concern,” Wan Kamaruzaman says, citing Basel III bank capital adequacy rules and IFRS accounting rules that will impact the EPF’s liquidity, particularly in areas such as Islamic sukuk bonds. The appreciation of the ringgit also impacts returns on global equities.

But “we have more problems at home than we do globally”, says Wan Kamaruzaman, noting that now is in fact a good time to enter many global sectors, where there is mispricing.

Also, the EPF is long-term by nature. It can’t make a sudden shift out of domestic markets. It has calculated that it can take up to two years to sell a position in a company where it owns 1-2% of the stock; in many cases it may own up to 20% of a company.

So there’s little wiggle room for tactical moves. However, the EPF is now adopting more tactical asset allocation strategies. It is expressing these more by outsourcing (or reducing external mandates) to local fund managers; and both domestically and internationally, the EPF wants to add more absolute-return mandates, in order to help it continue to pay members a high dividend.