Grey area: All's well with Malaysia and Singapore?

Malaysia and Singapore are often held up as paragons of virtue when the West looks for regional role models. Both navigated the Asian financial crisis admirably and both have high savings rates. Their respective sovereign wealth funds — Temasek Holdings, Government of Singapore Investment Corp. (GIC) and Khazanah Nasional - are managed by professionals and are comparatively more transparent than many similar funds in other jurisdictions. The national pension schemes, the Central Provident Fund (CPF) and Employee Provident Fund (EPF) — both defined contribution plans — have led the way in providing for pensions in Southeast Asia.

 But is all as good as it seems? The value of employment-based pension assets in Singapore have more than doubled in a decade, reaching $136bn by 2010, registering an annual growth rate of about 11.5%, according to data from the Asian Development Bank Institute. Malaysia’s pension assets have grown by an average 12.7% a year to $141bn. Both countries’ provident funds entered the top ten ranking for the first time in 2010 among 300 global pension funds by assets, according to a research by consultant Towers Watson.

Outside of their constituted pension systems, both governments have a surplus of savings as reflected in their current account balances. As a percentage of GDP, their current account surplus ranked the highest among countries in Asia, according to IMF data. Bank deposits are also supported by healthy household savings. In Malaysia, gross domestic savings are estimated at about 40% of GDP and in Singapore, the figure is about 50%, based on World Bank’s numbers. The mandatory savings nature of the CPF and EPF has contributed to high national savings rate.

 Singapore is aging fast

However, Malaysia and Singapore, like the rest of the developed world, are facing an aging population. The problem is more acute in these two countries. Singapore’s Ministry of Finance and also Temasek’s main shareholder, has identified “successful ageing” as one of the most significant challenges facing the government. Today, one out of every 12 Singaporeans is above the age of 65. By 2030, this ratio will become one in five, the highest among the six main economies of ASEAN, according the Centre for Strategic and International Studies (CSIS) and Manulife. In many ways, Malaysia’s demographics are more favourable than those of Singapore for building a sustainable retirement system. The country’s fertility rate is above the 2.1% replacement level, which will contribute towards a growing population and workforce for the coming decades.

 “We think the growth in Malaysia is quite good because of its young population, we are seeing healthy inflows into the pension system,” says Abdul Jalil Rasheed, the chief executive officer of Aberdeen Islamic Asset Management. “The challenge for

both Malaysia and Singapore is how pensioners will have enough to last them after working, especially in an environment of longer life spans in Asia.”

To its disadvantage, Malaysia has an early mandatory retirement age. An astonishing 92% of current retirees report that they had already left the workforce by age 60, according to a CSIS survey. Although the primary purpose of the CPF and EPF is to encourage savings for retirement, both systems allow members to use their balances for a variety of purposes, such as housing, education and medical services, which cuts retirement income.

 Pension to GDP ratio

The ratio of pension assets to 2010 GDP is about 65% for Singapore and 60% for Malaysia, according to the ADB Institute. While they ranked the highest among the Asia Pacific countries, the figures are behind those of Australia and much of the developed world. Towers Watson’s Global Pension Assets Study showed the ratio of pension assets to 2011 GDP is 107% for the US, 101% for the UK, 133% in the Netherlands and 115% in Switzerland.

CPF rates, though reviewed quarterly, typically stood at around 2.5% for the Ordinary

Account and 4% for the Special and Medisave Accounts. Singapore’s inflation rose to 5.3% year-on-year in June. Under arrangements between the Singapore government and the CPF Board, surplus CPF funds are placed with the government through the Monetary Authority of Singapore (MAS) for subscription of so-called Special Singapore Government Securities (SSGS). SSGS are non-marketable floating rate bonds issued specifically to CPF. The investment of CPF funds by the government relieves CPF from taking on the investment risk of a fund manager and allows it to concentrate on its role as a national social security institution, according to a July 2011 report by the Accountant General Department. By issuing SSGS to CPF and investing the proceeds from the borrowing, the Singapore government is one of the few countries in the world that explicitly recognizes and fully funds its national pension obligations, the report says.

 In Malaysia, the EPF paid out RM24.5bn ($7.9bn) to members in 2011, equivalent to a 6% dividend rate, the most since 2000. The fund paid 8.5% between 1983 and 1987, the highest since its inception in 1952. While CPF funds are invested in government securities, EPF’s assets comprise a mix of state and corporate bonds, equities, moneymarket bills and properties. As of December, about 27% of its assets are in government bonds. The pension fund plans to raise holdings of overseas investments to 30% by 2017 from the current 13%. Aberdeen’s Rasheed says: “I foresee that in the next 5 to 10 years most pension funds will have a large portion of their assets outside their home country as they become larger and more familiar with international markets.”

 Pensions and insurance

A recent Manulife Asset Management report shows fewer than 40% of Malaysians and less than half of Singaporeans are members of the formally constituted pension schemes. In OECD countries, so-called coverage rates averaged between 60% and 80%. Amid the growth of the nations’ wealth, greater numbers of pre-retirees are seeking additional savings, health care insurance and investment vehicles to complement their formal pensions.

 The stage is set for alternative savings mechanisms, such as mutual funds and insurance products, to grow significantly in the coming years, Manulife Asset said in a recent  report. David Norris, Manulife Financial Asia’s Director of Regional Communications, says there is evidence this trend is already starting to take place alongside reforms to formal pension schemes in ASEAN and the pace of these reforms to accelerate.

 To help boost retirement coverage and funding, Malaysia in July launched the Private Retirement Scheme to augment the EPF. In Singapore, the Supplementary Retirement

Scheme (SRS), a voluntary scheme to encourage individuals to save for retirement, over and above their CPF savings, was established in 2001.

 While it remains too early to pass judgment on Malaysia’s recently launched private pension system, the growth of Singapore’s SRS has been slow despite the fact the structure comes with attractive tax relief. The SRS is “still tiny” when compared with the dominance CPF in terms of assets under management and number of participants, says Yuwei Hu, Research Fellow at the Chinese Academy of Social Sciences and author of an ADB Institute report on Asian pension assets.

 The main reason may be that employees and employers already contribute to the CPF system with relative high rates, therefore leaving them less room to make voluntary savings on the top of CPF, adds Hu. The future of the private pension system in Malaysia may not be promising, he added.

 Wealth at retirement

As populations age in the decades ahead, older individuals will consume a growing share of resources, straining public and private balance sheets. “No other force is likely to shape the future of national economic health, public finances, and policymaking as the irreversible rate at which the world’s population is aging,”

Standard & Poor’s wrote in a report on global aging. Even in wealthier economies, finances will deteriorate, it warned.

 One of the means to help mitigate the burden of pension income is by building a

robust economy and creating jobs. Here the countries’ respective sovereign funds play a role. Hu says: “Expected fiscal pressure from the ageing population is one of the motivations for governments to enhance investment returns via active investment by sovereign funds.”

 Singapore’s GIC and Temasek managed a combined $405bn in assets, 1.6 times the

country’s GDP, while Malaysia’s Khazanah handles almost $40bn, about a sixth of its

economy, according to Sovereign Wealth Fund Institute. GIC, whose source of funds include the country’s balance of payments surpluses and accumulated national savings, has said it “has enhanced the government’s portfolio with returns averaging 3.9% per year, in addition to having protected the portfolio against global inflation.” Temasek’s shareholder return, which includes changes in the value of its assets and dividends, averaged 17% since its inception in 1974, according to its website. The company had a negative shareholder return of 30% in the year ended March 2009, then posted a 42% increase the following year.

 Singapore’s returns from reserves added about S$7bn ($5.6bn) a year to the city’s budget as the government seeks to spend more on infrastructure with an aging population, the Ministry of Finance said in July. Khazanah said in January while the value of its portfolio fell 7% last year to RM70bn, its profit before tax jumped 156.3% to RM5.3bn, enabling it to pay out a record dividend of RM3bn. The [success of the] sovereign funds of Malaysia and Singapore has been I would say good management [rather] than luck,” says Angus St John, Head of Sales, Southeast Asia, at J.P. Morgan Worldwide Securities Services. “They took the view that they were there to ensure, first of all, there was safety of assets for their members, minimal volatility, and also to generate returns.”

 Multi-pillar approach

The relative success of the sovereign funds of Singapore and Malaysia, their robust economies, general wealth creation and well-established pension systems, should contribute towards theirability to cope well, compared to most countries, with the fiscal pressure of an aging population. St John says: “Obviously they will continue to look at retirement age and contribution rates but if you compare them to many of the developed markets, I think they are in a very good position.”

 However, governments and private pension providers have been preparing for the financial consequences of aging based on forecasts that in the past have consistently underestimated how long people love, according to the IMF’s Global Financial Stability Report. If average life span in 2050 were to increase three years more than expected, the already vast cost of aging would increase by 50%. More attention to longevity risk is thus warranted, given the size of the financial impact.

 Manulife expects many countries to adopt a ‘multi-pillar approach’ similar in style to Malaysia and Singapore, where individuals save for retirement through a combination of formal pension programmes and other forms of organized saving such as life insurance and mutual funds.

 Still, says Hu: “Pensions benefits are eventually a burden for governments, therefore national fiscal capability is of crucial importance.”