Why EPF shuns hedge funds and smart beta

The deputy chief executive of Malaysia’s biggest state retirement fund tells AsianInvestor about its investment approach and where it sees opportunities.
Why EPF shuns hedge funds and smart beta

Like other institutional investors. Malaysia’s $161 billion Employees Provident Fund is exploring how it can maintain above-target returns in the current low-yield environment. Two things it does not use, however, are hedge funds and so-called ‘smart beta’ strategies. 

Smart beta – use of alternative index weightings to achieve above-benchmark returns – has suffered a backlash in recent months, after experiencing a rapid rise in popularity in the past couple of years.

While EPF’s investment team filters its exposure based on certain factors, “it is not a ‘smart-beta’ thing; we don’t do that”, said Mohamad Nasir Ab Latif, deputy chief executive and a 34-year veteran of the fund*. He told AsianInvestor he he did not see this as an affective approach, because “the moment everyone invests in the same way, the arbitrage disappears”.

Meanwhile, hedge funds do not fit EPF’s long-term buy-and-hold approach, he noted. “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."

The fund is, however, increasing its use of other alternative strategies, as reported. It aims to raise its overall allocation to the likes of infrastructure, private equity and real estate to 8-10% in the next three to five years, from 4% currently. This means it will be putting at least $65 billion more into such assets in that period. PE forms part of its 44% allocation to equities, while 51% of its portfolio is in fixed income.

EPF’s alternatives allocation 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,” said Nasir. “We are talking real assets, commercial buildings, shopping malls and logistics depots.” 

So where is EPF seeing opportunities now? “We are starting to expand into China,. Listed equity investments are accessed through H-shares and we also access real estate investment through funds as well as private equity.”

In Europe, the fund has started to diversify outside the US, or at least outside London, said Nasir. It is finding better value in Europe, such as in commercial buildings and logistics in Germany, France, the Netherlands and Poland. 

“We were a little slower to go into the US because of the tax structure there, but we have managed to get around that now.” In light of the relatively unfavourable American tax regime for funds, EPF has invested using real estate investment trusts and private equity focused on the major cities.

Asked how the fund achieved its return last year, Nasir said that in the first quarter it began taking profits, having made good returns in China, emerging and developed markets. The return went from around RM10 billion ($2.6 billion) in the first quarter to RM11.4 billion in the second, before falling to RM9.5 billion in the third.

EPF re-allocated some of its China allocation to Europe and other developed markets in 2015, he added, while staying close to its strategy asset allocation.

“A lot of Asian markets came off pretty badly last year,” said Nasir. “Having said that, towards the later part of the year, when value emerged in some markets, we moved money back into Asia.”

* The full Q&A interview with Nasir appears in the latest (April) issue of AsianInvestor magazine.

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