Investing public funds in the stock market

From Sunday Island 08/06/2014

The Employees Provident Fund (EPF), the retirement fund of private sector employees to which their employers and they themselves make monthly contributions, today controls a massive Rs. 1,300 billion. It is certainly no Golden Key and however much some of its stock market investments may be kept in the public eye by opposition MP Harsha de Silva, once labeled the UNP’s ``economic hit man’’ by Governor Cabraal, nobody can credibly say that its 2.4 million members have fears of not getting their money when they want it. The fund, for which the Labour Department too has a statutory responsibility, is administered by the Central Bank and our sister paper, The Island, last week ran an interview with Governor Ajith Nivard Cabraal on the many issues that de Silva, functioning as a good opposition parliamentarian should, keeps raising frequently.

Any stock market investor would (or should) know you cannot win on all the share market investments you make unless you are a genius blessed with a canny instinct that unerringly takes you where the big bucks are. But they also know that if they are patient and resource rich, and not inclined to gamble on shares which lack fundamental strength, they generally cannot go wrong and can make good profits for themselves as many do. Given its resource base, the EPF which for long was a captive lender to government, can make good profits for its members by prudent stock market investment. Time was when the dividend on members’ balances was less than prevailing inflation rates and EPF members were actually losers on their money held in the fund. But that ended many years ago and for the past several years, the fund has been giving its members a decent return and also regularly posting them on their balances held in the fund. A few people may have trouble getting their EPF savings refunded, but that has nothing to do with the fund not having the ability to meet calls on it. It has everything to do with the necessary documentation not being in order and neither the fund nor its administrators can be blamed for that. They must necessarily make sure that the money goes to people to whom it belongs and no other and berating them for doing that serve no useful purpose.

In his interview with The Island Cabraal has said that until around 2001, the EPF invested all its resources in government securities - the so-called gilts. The decision to invest in the equity market was taken at that time. However, even up to now only a very small percentage of the EPF’s holdings is invested in equity – less than six percent (Rs. 72 billion) in shares. But the governor says that the fiscal debt is being progressively reduced today and he foresees that government borrowing will decline in the future. To borrow his words, ``the EPF is one of the biggest lenders to the government and the biggest borrower of EPF money has clearly indicated that they may not borrow as much in the future.’’ Added to that is the fact that interest rates have been coming down and the halcyon days when the National Savings Bank paid 22 percent on one year fixed deposits when the J.R. Jayewardene government in 1978 opened an economy shackled for decades is long gone. Today bank deposit rates are in single digits. It is possible to get more from finance companies but the good ones barely offer 11 percent at present. Given the unhappy experiences many investors have had with fly-by-night financial sector borrowers, the Central Bank has capped interest rates that can be paid but allowed some flexibility which has enabled some companies to offer a slightly better rate for 13-month maturities rather than the usual 12-months.

Be that as it may, many middle class people, most of them in the twilight years of their lives, are hard hit by the falling deposit rates both in banks and in finance companies. There is little or nothing the government can do about this because it cannot force situations where companies are made to pay deposit rates higher than the rates at which they can lend. Greater the risk, greater the reward is a proven economic maxim. People flocked to Golden Key to get crazily high interest rates and are paying the price despite previously bad market experiences. The Central Bank (CB) is now in the process of trying to reduce the number of finance companies in operation by pushing the stronger entities to absorb the weaker one. It must be faulted for allowing new finance companies to open in a market which was already saturated and then trying (in a fashion) to `compel’ mergers and acquisitions under conditions including keeping all present employees in their jobs – no doubt a political imperative. The CB must blame itself for issuing new licences in this context.

Recently the Chairman of the Ceylon Tobacco Company said in its annual report that if a shareholder had invested a thousand rupees in CTC shares on January 1, 2009, and sold these shares on December 31, 2013, his/her total return would have been Rs. 23,596 including share price appreciation and dividends, providing a total gain of 2,260 percent!

Given that CTC is the manufacturer of a controversial product, it is unlikely that the EPF would have cashed in on such investment opportunities, however seductive. Admittedly an exception, it is yet an indication of the possibilities of investing in listed shares. There are quite a few companies like CTC who have given exceptional returns to their shareholders who have done very nicely in terms of both high dividends and capital appreciation. The EPF is a substantial shareholder of many such companies particularly in the banking sector. Yet it has been pointed out to Cabraal that the return on share investments by the fund in the last three years, both in terms of dividends and capital gains realized, had been 3.2%, 4.8% and 4.5% against 11% and more from government securities. So why invest in shares, the governor was asked.

His response has been logical. The share portfolio of the EPF was relatively young while its government securities portfolio is mature, still holding treasury bonds issued years ago and earning high interest. So the 11% will not be a permanent feature and it is necessary that the fund builds a good portfolio of shares as well which in the future will provide a reasonable return to members. The government today, using the influence of share portfolios held not only by the EPF but also by the Employees Trust Fund and the Sri Lanka Insurance Corporation, which went into stock market investments much earlier, have been making board appointments to listed banks among others. While many such appointments are good, there have been at least a few that are questionable. Today a place on the board of many blue chip companies, even in an independent non-executive capacity, entails better than six figure monthly emoluments. This is an instrument of patronage that most politicians would be tempted to use. As long as there are no investments in crony companies, and there have been some such, prudently diversifying the EPF portfolio into companies with strong fundamentals must be encouraged. We also need MPs like Harsha de Silva to keep their eyes peeled on the way the game is played.
http://island.lk/index.php?page_cat=article-details&page=article-details&code_title=104731