By Nihal Rodrigo
The Employees’ Provident Fund (EPF) has been earning above-average profits in the recent past, but unfortunately, there have been grossly unfair criticisms and outrageous allegations made by certain parties against the EPF. Therefore a detailed analysis seems to be warranted.
Further, as far as rates of returns are concerned, EPF has been able to declare impressive rates of return of 13.75 percent in 2009, 12.5 percent in 2010, 11.5 percent in 2011, 11.5 percent in 2012 and 11 percent in 2013 out of profits earned by the Fund. Such rates of return were substantially above the interest rates applicable to normal deposits in the financial market during the respective periods. In that background, it is clear that the allegations against the EPF are baseless, and are obviously motivated by dubious intentions.
Some persons have specifically claimed that the EPF has incurred losses amounting to over Rs.11 billion in 2011 from the investments that it has made in the stock market. There is absolutely no truth in such a claim and that is an erroneous and misleading allegation, since the “losses” that these claims have highlighted are not realized losses, but unrealized reductions in value of investments.
In actual fact, EPF has not incurred any realized losses at all in its stock market operations, but has earned realized gains in the amounts of Rs.714 million in 2011, Rs.1,020 million in 2012 and Rs.113 million in 2013.
As persons knowledgeable in stock market operations very well know, when a person invests in the stock market or in the equity of corporates, the stock prices may move up and down from time to time. In fact, it is an inherent feature of any market. Hence, if shares purchased in the past are revalued at a time when market prices have declined, there would be a fall in the value of the investment. But it is not an actual loss. An actual loss would materialize only if those shares are sold at such depressed prices. If shares are not disposed at the reduced prices, the reduction in value arising from such revaluations is described as “unrealized losses”. At the same time, if shares purchased in the past are revalued at a time when market prices have increased, there would be a gain in the value of the investments. But that too, is not an actual profit. An actual profit would be earned and realized, only if those shares are sold at such increased prices. If shares are not disposed at the increased prices, the increase in value arising from such revaluations is described as “unrealized gains”.
Long-term focus
The EPF invests in the stock market with a long- term focus, and not with a short-term perspective. Therefore, unrealized gains or losses arising from short-term fluctuations in prices do not affect the profits of EPF. The reason for this outcome is that the EPF does not have any financial difficulties nor does it have any urgency to sell any shares at a loss.
This is because of the fact that EPF has more than adequate funds to meet its day-to-day obligations and to make refunds to members and other payments, and its average daily inflows are far greater than that of its average daily outflows. What are invested are the excess funds remaining after meeting all obligations. Therefore, the EPF will not need to sell its investments at a loss to raise funds for its daily operations.
It must also be noted that the amount of unrealized gains and losses changes from time to time. For instance, the net unrealized gain as at December 31, 2010 was nearly Rs.18 billion. However, at such time, today’s vociferous political critics were deafeningly silent and did not acknowledge the massive unrealized gains appearing in the books of the EPF.
Further, just because the EPF had such large unrealized gains at that time, it did not sell all its investments to realize the gains, because EPF is a long-term investor. It is only if the investment managers of the EPF are satisfied that the unrealized gains are substantial, and they believe it is the right time to sell, that they sell such shares and realize the profits.
With the downturn in the share market, the net unrealized gain of nearly Rs.18 billion at the end 2010, gradually moved into negative territory, and turned into a net unrealized loss of about Rs.9 billion by the end of 2013. However, by April 22, 2014, the net unrealized loss had reduced to about Rs.4.4 billion, and by May 2, 2014, it has come down further to about Rs.2.9 billion! Hence, it would be seen that since of late, with the recent upturn in the stock market, it is likely that the net “unrealized loss” that have been made use of by some persons to discredit the EPF, will turn into a net unrealized gain in the near future, thus causing deep embarrassment to these elements.
It must also be clearly understood that these unrealized losses do not affect the returns paid to members. In fact, when there were large net unrealized gains, it did not result in an additional return being credited to the members. In the same way, when there are net unrealized losses, it will not adversely affect the returns to be credited to the members.
Only actual realized gains or realized losses are considered when arriving at profits or losses of the EPF.
Investing in stock market
Another claim that is sometimes made is that if EPF had not invested in the stock market, it would not have been subjected to this sort of losses. In that regard, it must be stated, that these claims too, are without a rational basis. The stock market is an alternative avenue available for investment, in addition to government securities. When investors invest in the stock market, they always do so on the basis that diversification is a fundamental principle of portfolio management. That means investing in different types of assets and not “putting all their eggs in one basket”. There is a high risk if a person invests only in one or two assets or asset classes. That is known to every investor. It must also be noted, that with the fiscal consolidation planned by the government where the budget deficits are being reduced gradually to below 4% of GDP, the need for government borrowings are also gradually reducing. As a result, the EPF has to find new investment avenues to invest its funds. This is another reason for the EPF to explore new investment avenues. Not only for the EPF, but for all pension funds from all over the world, stocks are a major asset class for investment purpose. Therefore, because of some politically motivated allegations and criticisms, if the EPF refrains from diversifying into different asset classes, the risks could be much greater in the future for its members, and that would be detrimental in the long term.
Selection of stock investments
Another criticism that has been leveled against the EPF is that its investment activities have been carried out arbitrarily and have been not in line with best investment practices. In this connection, it must be stated that in terms of the provisions of the EPF Act, the Commissioner of Labour is vested with the decisions pertaining to the administration of the Fund, while the Monetary Board of the Central Bank of Sri Lanka, as the custodian of the Fund, is empowered to make decisions relating to investment activities. Accordingly, the investments are made, based on a set of guidelines and policies, which are from time to time, updated and approved by the Monetary Board.
Accordingly, the Fund has a set of rules, guidelines and an organizational structure to undertake investment activities. Thus, there is no room for making arbitrary investments since there is laid down procedure for making all investments, as well as conducting the investment operations of the Fund. For instance, new investments/ proposals/observations made by fund managers have to be submitted to the Investment Committee (IC) appointed by the Monetary Board for evaluation and analyses. The responsibility of the IC is to make its recommendations to the Monetary Board. Thereafter, having considered the recommendations, the Monetary Board, makes a final decision on such investments.
Moreover, prior approval is obtained from the Monetary Board for the expected investment plan for the following month. It should also be noted that investment activities of the Fund are performed by a team of well-trained officers who possess the required educational and professional qualifications in the respective fields. At the same time, the EPF takes many factors into consideration when stock market investments are carried out.
These include the intrinsic value of stocks and their future prospects, possible rise in value of stocks in the medium to long term, organizational structures and future plans of companies, the number of stocks in issue of such companies, viability and growth potential of the relevant industry, and possible impact of the emerging economic activities on the company.
Financial statements
In the recent past, there have also been allegations that the EPF financial statements have not prepared and issued in time. This claim is also not correct. The EPF has prepared all its financial statements of every year in time, and submitted such financial statements to the Auditor-General and the Minister of Labour within the first two months, and three months respectively, of the following year. The highlights of the financial statements have also been published in newspapers within the first six months of the following year.
Accordingly, the financial statements for years up to 2013 have already been submitted to the Auditor-General. Once the Auditor General hands over the audited financial statements after completing the audit of such statements, those are submitted to the Minister of Labour to be tabled in the Parliament. The process of submitting financial statements to Parliament may sometimes take a longer time than anticipated due to the legislature procedures. However, it must also be stated that all members of the Fund have received their member balances within six months of the end of the year, and on that basis if, as alleged, the financial statements were not prepared on time, the Fund would not have been able to send half yearly individual statements to all its active members.
Another matter that has to be highlighted is that the EPF has been able to maintain its operational costs at less than 1 percent of the Fund value, which is by far, one of the lowest cost ratios in the world! In fact, in 2013, this was only 0.9 percent. This is a very good outcome in comparison to the costs incurred by similar funds in other parts of the world! Generally, a management fee of about a 2 to 3 percent is charged by private fund managers, for the management of a Fund, but the EPF has managed its funds at less than 1 percent, even while out-performing the others, and distributing those benefits amongst its members.
Returns from EPF Fund
Further, when one is referring to the returns of the fund, the total returns of the fund must be considered, without dissecting the individual items in a large portfolio, on a selective or piece-meal basis. In that context, it must be appreciated that what matters in the final analysis is as to whether EPF was able to earn a high rate of return for its members, relative to such other similar funds. Accordingly, it is abundantly clear that the trust placed in the Monetary Board of the Central Bank by the EPF Act has been well-founded in the past, and will be preserved in the future too.
It must also be stated that a Fundamental Rights action was filed against the EPF in 2012 by several politically motivated persons and others, alleging impropriety relating to EPF’s investments in the stock market. But, as is well known, after a preliminary hearing, the Supreme Court dismissed the petition without even granting leave to proceed. In that background, the EPF wishes to inform the public, and especially its members, that these vituperative and well-planned allegations and actions against the EPF are without foundation, and therefore the members must not to be misled by these politically motivated claims. At the same time, it must be further stated that instead of leveling criticisms against EPF, it should be commended for being able to earn a consistently high rate of return for its members.
(This article by the Superintendent of EPF was sent to us by a Deputy Governor of The Central Bank of Sri Lanka with a view to address concerns raised by media reports recently)
www.nation.lk
The Employees’ Provident Fund (EPF) has been earning above-average profits in the recent past, but unfortunately, there have been grossly unfair criticisms and outrageous allegations made by certain parties against the EPF. Therefore a detailed analysis seems to be warranted.
The EPF is, by far, the biggest profit earning entity in the country. For instance, during the last five year period from 2009 -2013, the EPF has earned a total profit of Rs.558 billion! There is no other entity with a comparable asset base earning such an enormous profit in the country. In absolute terms, EPF has made profits of Rs.101.7 billion in 2009, Rs.111.5 billion in 2010, Rs.107.5 billion in 2011, Rs.111.8 billion in 2012 and Rs.125.6 billion in the year 2013.
Further, as far as rates of returns are concerned, EPF has been able to declare impressive rates of return of 13.75 percent in 2009, 12.5 percent in 2010, 11.5 percent in 2011, 11.5 percent in 2012 and 11 percent in 2013 out of profits earned by the Fund. Such rates of return were substantially above the interest rates applicable to normal deposits in the financial market during the respective periods. In that background, it is clear that the allegations against the EPF are baseless, and are obviously motivated by dubious intentions.
Some persons have specifically claimed that the EPF has incurred losses amounting to over Rs.11 billion in 2011 from the investments that it has made in the stock market. There is absolutely no truth in such a claim and that is an erroneous and misleading allegation, since the “losses” that these claims have highlighted are not realized losses, but unrealized reductions in value of investments.
In actual fact, EPF has not incurred any realized losses at all in its stock market operations, but has earned realized gains in the amounts of Rs.714 million in 2011, Rs.1,020 million in 2012 and Rs.113 million in 2013.
As persons knowledgeable in stock market operations very well know, when a person invests in the stock market or in the equity of corporates, the stock prices may move up and down from time to time. In fact, it is an inherent feature of any market. Hence, if shares purchased in the past are revalued at a time when market prices have declined, there would be a fall in the value of the investment. But it is not an actual loss. An actual loss would materialize only if those shares are sold at such depressed prices. If shares are not disposed at the reduced prices, the reduction in value arising from such revaluations is described as “unrealized losses”. At the same time, if shares purchased in the past are revalued at a time when market prices have increased, there would be a gain in the value of the investments. But that too, is not an actual profit. An actual profit would be earned and realized, only if those shares are sold at such increased prices. If shares are not disposed at the increased prices, the increase in value arising from such revaluations is described as “unrealized gains”.
Long-term focus
The EPF invests in the stock market with a long- term focus, and not with a short-term perspective. Therefore, unrealized gains or losses arising from short-term fluctuations in prices do not affect the profits of EPF. The reason for this outcome is that the EPF does not have any financial difficulties nor does it have any urgency to sell any shares at a loss.
This is because of the fact that EPF has more than adequate funds to meet its day-to-day obligations and to make refunds to members and other payments, and its average daily inflows are far greater than that of its average daily outflows. What are invested are the excess funds remaining after meeting all obligations. Therefore, the EPF will not need to sell its investments at a loss to raise funds for its daily operations.
It must also be noted that the amount of unrealized gains and losses changes from time to time. For instance, the net unrealized gain as at December 31, 2010 was nearly Rs.18 billion. However, at such time, today’s vociferous political critics were deafeningly silent and did not acknowledge the massive unrealized gains appearing in the books of the EPF.
Further, just because the EPF had such large unrealized gains at that time, it did not sell all its investments to realize the gains, because EPF is a long-term investor. It is only if the investment managers of the EPF are satisfied that the unrealized gains are substantial, and they believe it is the right time to sell, that they sell such shares and realize the profits.
With the downturn in the share market, the net unrealized gain of nearly Rs.18 billion at the end 2010, gradually moved into negative territory, and turned into a net unrealized loss of about Rs.9 billion by the end of 2013. However, by April 22, 2014, the net unrealized loss had reduced to about Rs.4.4 billion, and by May 2, 2014, it has come down further to about Rs.2.9 billion! Hence, it would be seen that since of late, with the recent upturn in the stock market, it is likely that the net “unrealized loss” that have been made use of by some persons to discredit the EPF, will turn into a net unrealized gain in the near future, thus causing deep embarrassment to these elements.
It must also be clearly understood that these unrealized losses do not affect the returns paid to members. In fact, when there were large net unrealized gains, it did not result in an additional return being credited to the members. In the same way, when there are net unrealized losses, it will not adversely affect the returns to be credited to the members.
Only actual realized gains or realized losses are considered when arriving at profits or losses of the EPF.
Investing in stock market
Another claim that is sometimes made is that if EPF had not invested in the stock market, it would not have been subjected to this sort of losses. In that regard, it must be stated, that these claims too, are without a rational basis. The stock market is an alternative avenue available for investment, in addition to government securities. When investors invest in the stock market, they always do so on the basis that diversification is a fundamental principle of portfolio management. That means investing in different types of assets and not “putting all their eggs in one basket”. There is a high risk if a person invests only in one or two assets or asset classes. That is known to every investor. It must also be noted, that with the fiscal consolidation planned by the government where the budget deficits are being reduced gradually to below 4% of GDP, the need for government borrowings are also gradually reducing. As a result, the EPF has to find new investment avenues to invest its funds. This is another reason for the EPF to explore new investment avenues. Not only for the EPF, but for all pension funds from all over the world, stocks are a major asset class for investment purpose. Therefore, because of some politically motivated allegations and criticisms, if the EPF refrains from diversifying into different asset classes, the risks could be much greater in the future for its members, and that would be detrimental in the long term.
Selection of stock investments
Another criticism that has been leveled against the EPF is that its investment activities have been carried out arbitrarily and have been not in line with best investment practices. In this connection, it must be stated that in terms of the provisions of the EPF Act, the Commissioner of Labour is vested with the decisions pertaining to the administration of the Fund, while the Monetary Board of the Central Bank of Sri Lanka, as the custodian of the Fund, is empowered to make decisions relating to investment activities. Accordingly, the investments are made, based on a set of guidelines and policies, which are from time to time, updated and approved by the Monetary Board.
Accordingly, the Fund has a set of rules, guidelines and an organizational structure to undertake investment activities. Thus, there is no room for making arbitrary investments since there is laid down procedure for making all investments, as well as conducting the investment operations of the Fund. For instance, new investments/ proposals/observations made by fund managers have to be submitted to the Investment Committee (IC) appointed by the Monetary Board for evaluation and analyses. The responsibility of the IC is to make its recommendations to the Monetary Board. Thereafter, having considered the recommendations, the Monetary Board, makes a final decision on such investments.
Moreover, prior approval is obtained from the Monetary Board for the expected investment plan for the following month. It should also be noted that investment activities of the Fund are performed by a team of well-trained officers who possess the required educational and professional qualifications in the respective fields. At the same time, the EPF takes many factors into consideration when stock market investments are carried out.
These include the intrinsic value of stocks and their future prospects, possible rise in value of stocks in the medium to long term, organizational structures and future plans of companies, the number of stocks in issue of such companies, viability and growth potential of the relevant industry, and possible impact of the emerging economic activities on the company.
Financial statements
In the recent past, there have also been allegations that the EPF financial statements have not prepared and issued in time. This claim is also not correct. The EPF has prepared all its financial statements of every year in time, and submitted such financial statements to the Auditor-General and the Minister of Labour within the first two months, and three months respectively, of the following year. The highlights of the financial statements have also been published in newspapers within the first six months of the following year.
Accordingly, the financial statements for years up to 2013 have already been submitted to the Auditor-General. Once the Auditor General hands over the audited financial statements after completing the audit of such statements, those are submitted to the Minister of Labour to be tabled in the Parliament. The process of submitting financial statements to Parliament may sometimes take a longer time than anticipated due to the legislature procedures. However, it must also be stated that all members of the Fund have received their member balances within six months of the end of the year, and on that basis if, as alleged, the financial statements were not prepared on time, the Fund would not have been able to send half yearly individual statements to all its active members.
Another matter that has to be highlighted is that the EPF has been able to maintain its operational costs at less than 1 percent of the Fund value, which is by far, one of the lowest cost ratios in the world! In fact, in 2013, this was only 0.9 percent. This is a very good outcome in comparison to the costs incurred by similar funds in other parts of the world! Generally, a management fee of about a 2 to 3 percent is charged by private fund managers, for the management of a Fund, but the EPF has managed its funds at less than 1 percent, even while out-performing the others, and distributing those benefits amongst its members.
Returns from EPF Fund
Further, when one is referring to the returns of the fund, the total returns of the fund must be considered, without dissecting the individual items in a large portfolio, on a selective or piece-meal basis. In that context, it must be appreciated that what matters in the final analysis is as to whether EPF was able to earn a high rate of return for its members, relative to such other similar funds. Accordingly, it is abundantly clear that the trust placed in the Monetary Board of the Central Bank by the EPF Act has been well-founded in the past, and will be preserved in the future too.
It must also be stated that a Fundamental Rights action was filed against the EPF in 2012 by several politically motivated persons and others, alleging impropriety relating to EPF’s investments in the stock market. But, as is well known, after a preliminary hearing, the Supreme Court dismissed the petition without even granting leave to proceed. In that background, the EPF wishes to inform the public, and especially its members, that these vituperative and well-planned allegations and actions against the EPF are without foundation, and therefore the members must not to be misled by these politically motivated claims. At the same time, it must be further stated that instead of leveling criticisms against EPF, it should be commended for being able to earn a consistently high rate of return for its members.
(This article by the Superintendent of EPF was sent to us by a Deputy Governor of The Central Bank of Sri Lanka with a view to address concerns raised by media reports recently)
www.nation.lk
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