Sovereign wealth funds are being tapped for capital the world over to support their domestic economies in the wake of the coronavirus crisis – that is, after all, what many were set up for.

But Malaysia’s Khazanah Nasional is feeling the pinch more than most, so much so that its chief executive and more foreign branches may be for the chop.

In its annual review, released on Thursday (March 4), the state investor reported a 61% drop in profits and a similarly sharp drop in returns, largely on the back of the poor performance of local public markets.

“We expect a lot of cost-cutting measures in the fund to continue to reduce debt and improve performance,” said US think tank Global SWF in a post released on Thursday evening Hong Kong time. “This could see more overseas offices closed. Khazanah has already shut its London and Istanbul offices, but San Francisco could be next.”

The San Francisco branch has already seen some personnel cuts, Diego Lopez, New York-based managing director of Global SWF, told AsianInvestor.

There is also speculation that chief executive Shahril Ridza Ridzuan is set to leave, and Jeffri Salim Davidson, the current head of conglomerate Sime Darby, is reportedly a potential replacement. 

Raslan Sharif, Khazanah's head of corporate communications, did not respond to emailed requests for comment for this article sent late after working hours on Friday (March 5).

The rate of return for Khazanah’s RM93.5 billion ($23 billion) commercial fund, which contains its investable assets, was just 1.5% on a two-year rolling basis after it reported 8.3% the previous year.

That's “a disappointing result that undershoots the inter-generational long-term investment pool target”, said Global SWF, adding that the 61% slump in annual profits to RM2.9 billion was a “dismal performance”. 

The fund's total assets under management, including its $8 billion-odd strategic fund, fell from around $33 billion to $31 billion or by 9.4% in ringgit terms, added Lopez.

DOMESTIC ASSETS UNDERPERFORM

The "main weakness" is the domestic-heavy nature of Khazanah’s portfolio, which is two-thirds comprised of local assets despite paring its exposure to Malaysian stocks, said the think tank (see chart above). Last year Malaysia’s stock market gained just 2.4% while its GDP growth fell 5.6%, as against a rise of 14.1% for the MSCI World Index and a drop in worldwide economic growth of 3.5%.

Consequently, the domestic public market investments – representing half the fund – and Malaysian private equity allocation posted losses of 7.8% and 6.4%, respectively (see chart below). This was offset by growth in global public markets of 26.2%.

Khazanah had shifted its focus onto domestic economic development with the scaling back of its international teams in 2019, said Javier Capape, director of sovereign wealth research at Madrid-based IE University’s Center for Governance and Change.

Khazanah's commercial fund returns
(Source: Khazanah; Click for full view)

This has taken place as other state-linked investors, such as Employees’ Provident Fund (EPF) and unit trust manager PNB, have been ramping up their offshore exposure with a view to improving returns and diversification.

As a result of Khazanah’s strategy shift, its domestic positions are heavily exposed to sectors that were most impacted by the pandemic, resulting in heavy losses and impairments, said Global SWF.

A notable example is embattled Malaysia Airlines, for which Khazanah recently approved the first phase of debt restructuring. Since the end of 2020, the fund has injected MYR3.6 billion into the company.

The airline now represents around 23% of the $8 billion-odd strategic fund’s total AUM, the think tank said, adding: “The flag carrier remains a ball and chain on the fund.”

INCREASING LIQUIDITY

Shahril Ridza Ridzuan:
Set to depart?

What’s more, Khazanah's commercial fund divested RM13.2 billion in assets – more than twice the RM5.6 billion it invested – as it sought to increase liquidity in its portfolio, said Global SWF.

Indeed, exposure to cash in the commercial fund shot up from 1% in 2018 of AUM to 7% in 2020, while the allocation to foreign listed equities grew from 12% to 17%. This is in line with the rebalancing and diversification of the portfolio to improve risk-adjusted returns, the think tank said.

All this being said, despite the pandemic dealing Khazanah a major blow, “ongoing restructuring has ensured it remains profitable and debt is being steadily cut even as dividends to the government grow”, said Global SWF.

The fund is still performing better than the RM6.3 billion loss posted in 2018 before it began its portfolio restructuring, added the research house, and it reduced debt by 6% last year to RM43.1 billion.

Nevertheless, “the government has placed its subsidiaries under increased scrutiny”, with recent changes at the top of EPF and electricity utility Tenaga. Hence the uncertainty over the future of Ridzuan, who had taken on the role in August 2018.

“Even as the pandemic subsides,” concluded Global SWF, “the Malaysian economy continues to face significant risks, notably the unwinding of the household credit boom, which has the potential to lead to a collapse in domestic demand.”