Tuesday, March 13, 2007

EPF Sacrificed Returns for Control?

In a press conference by Employee Provident Fund (EPF) CEO, Datuk Azlan Zainol on Friday, he was reported to have given several reasons for the acquisition of Rashid Hussain Berhad.

He said that EPF wanted to “increase exposure to a sector that has good long term prospects”. He also expects a 6% - 7% return on capital over one to two years. Beyond that, the returns could be as high as 8% to 10%. In addition, he cited that the decision was made to “protect EPF investment” rather than “let it go”.

Are these good or credible reason to take on significantly higher risks posed by the acquisition of a commercial bank?
  • Firstly, as a prudent investment fund, the manner in which one should “increase exposure” to the banking sector is to make an evaluation of the various banks and invest in them according to their performance as well as the strength of their existing management. EPF should not be acquiring an entire bank, which is widely recognised as not among the leading performers, and then appoint new managers for the bank (because EPF itself has no expertise).

    In addition, Datuk Azlan has stated that EPF intends to dispose its current interest in other, possibly better performing banking groups. Clearly the acquisition of RHB Bank has placed EPF in the awkward position of being a owner of a bank which conflicts with its charter as an objective fund manager seeking to invest in the best performing companies.

    He added specifically that EPF will be disposing its equity holdings in other banks to avoid conflict of interests. This means that the decision to invest or divest is no longer a function of likely investment returns. Hence, has EPF sacrificed returns in exchange for the control of a bank?

    A good and prudent fund manager does not increase its exposure to a sector by betting all its eggs in one basket, in this case, RHB. The RM10 billion new investment represents more than 20% of its RM49.6 billion equity allocation based on its 2005 Annual Report. Such disproportionate amount of investment in a single stock clearly represents poor portfolio allocation and diversification.

  • Secondly, it is curious how Datuk Azlan came up with his 6%-7% over one to two years, and as high as 10% thereafter. With no concrete plans presented as well as so much uncertainty over the future management and other new potential shareholders, did he pluck his estimates from thin air? Datuk Azlan also failed to mention that such aggressive returns also mean substantially higher risks for EPF which may very well result in equally substantial losses.

    Datuk Azlan claimed that he could not remember that EPF's prior investment in RHB Bank which averages around RM10 per share, is worth only about RM4.60 today. And at its low, was worth only RM0.50, a 95% paper loss just two years ago. At the same time, despite predicting the higher returns, he refused to give an assurance that the life savings of the people will be protected, claiming that there is “no guarantee in business”. Will Datuk Azlan be prepared to resign as the CEO of EPF if the RHB investment does not generate the “expected returns”?

  • Thirdly, it is a very poor investment strategy to simply acquire the entire bank to protect its existing 31.7% stake. Such a strategy could easily backfire on EPF and its contributors. Any attempts to average down the cost of EPF's stake in the bank without an independent look at where RM10 billion will be able to generate better and less risky returns will just be a case of throwing good money after bad.
What is most baffling is EPF's argument that after the acquisition exercise, it will then seek to reduce it stake in the Bank by selling some 35% stake to 2-3 strategic investors. If these investors are crucial to improving the performance of the bank, why aren't EPF teaming up with them in advance to bid for the Bank? If EPF claims it can place out the shares of the Bank at higher prices to interested parties hence making a quick profit, why didn't these parties participate in the competitive bid for the bank? And if EPF hasn't identified the new strategic investors, isn't the Board of EPF putting the cart before the horse, placing great risks to the retirement funds of Malaysian workers?

Clearly the above questions demonstrate that the entire acquisition by EPF Board was a “buy first, think later and hope for the best” exercise. EPF should stick to its charter to prudently manage the retirement funds of Malaysian workers utilising low risk strategies such as a diversified portfolio in equities to generate safe and reasonable returns. EPF has no business attempting to be a “business owner” which leads to re-aligned objectives and incentives as well as significantly higher risks.
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