Malaysia’s $160 billion Employees Provident Fund (EPF) has announced details of its proposed new sharia-compliant fund, which will operate as a segregated portfolio within the state pension fund itself.

To begin operating in 2017, the ‘simpanan syariah’ will have an initial size of RM100 billion ($25 billion) and will be open for registration by scheme members from August 8.

In this first phase, the sharia assets will be managed in-house. As this is the first time EPF has operated a formalised sharia portfolio, the fund will be managed in-house but the board may look at new external mandates as the sharia fund grows.

EPF chief executive Shahril Ridza Ridzuan said the goal was to target the same returns in the long term across both conventional and sharia portfolios. "So you should expect similar long-term returns, but will not see the same dividends in any given year,” he said.

The main difference between the conventional and sharia portfolios is a higher weighting in financial stocks in the conventional portfolio. The sharia-compliant fund cannot invest in banks and insurance companies. Over the long term, this would mean a variance in annual performance in the range of 50 basis points, said Ridzuan.

The plan for a segregated sharia fund was originally outlined by the EPF’s deputy chief investment officer Mohamad Nasir Ab Latif in an exclusive interview in the April edition of AsianInvestor magazine.

Nasir said at the time that the EPF had calculated how much of the portfolio could be segregated in this way at between RM100 billion and RM150 billion. This suggests the fund may yet allocate more assets to the sharia portion, depending on demand.

Ridzuan confirmed the EPF would have a second tranche available at a later date “once we know the demand and availability of funds", he said.

At present, 42% of EPF's RM685 billion in assets are managed according to sharia principles. “If all of our members want sharia, I don’t have enough assets, which is a challenge,” Nasir told AsianInvestor.

“It is quite impractical to be 100% sharia-compliant and move away from the strategic objective of giving contributors a choice,” noted Ridzuan. “If the sharia fund is too big, we will have an issue in terms of having enough assets in certain asset classes that can give us the same kind of risk returns spread over the long term."

Despite the limitations within the sharia fund, he added, the overall portfolio allocation to banks and insurance companies would not be materially affected, since the fund has been positioning the fund’s investments over the last four years in preparation for the change.

He said the sharia fund would still invest in Islamic banking and takaful insurers, many of which are listed on Bursa Malaysia. “The large majority of Bursa components are sharia-compliant already, so, it is not so much of an issue,” Ridzuan noted.