Thursday, 8 October 2015

How CPF invests your money.

As far as most people are concerned, this is all they understand... or need to understand:

As far as most citizens are concerned, CPF = Govt.

If they do a little bit of reflection and/or research, they will realise that interests don't grow on trees. They need to be invested. And so they may have this idea:

CPF = Govt = GIC.

And if they "think" a little more deeply, they may conclude, CPF = Govt = GIC = PAP.

And they see the huge returns on the GIC investments compared to the small interest they get from the CPF, and they wonder, "Hey! Why aren't those returns coming to me?"

(And some may go off track and slander the PM).

So it seems obvious to ask if, instead of going through the Govt, can't we go straight to the GIC for some of that sweet, sweet investment returns? Like this:

Well, for now you can't because the GIC is a private company solely owned by the Government of Singapore (not the PAP), and they issue no shares or bonds.

But that's a technicality. They could issue bonds.

But noticed the red arrows in the above? Those indicate risks. Buying SSGS bonds is practically risk-free (blue arrows), and CPF is guaranteed a coupon rate that enables the CPF to pay 4% and 2.5% interests to members. [Note the careful phrasing here. I am not saying that the SSGS pays 4% and 2.5%. I do not know how that would work. But whatever the coupon rate for the SSGS bonds, it allows the CPFB to pay the members 4% and 2.5%. Note the underlined text in the quoted item below.]

From MOF website
SSGS are non-tradable bonds issued specifically to the Central Provident Fund (CPF) Board, Singapore’s national pension fund. Singaporeans’ CPF monies are invested in these special securities which are fully guaranteed by the Government. The securities earn for the CPF Board a coupon rate that is pegged to CPF interest rates that members receive.
[Note: "Pegged to" does not mean "Equal to".]

SSGS bonds are non-tradable. They were specially created for CPF, sold only to CPF, and on maturity redeemed by the CPF. With normal (tradeable) bonds, when you want to realise your investment, you can sell your bonds to others. But with these SSGS, you have to hold til maturity.

Which is not a problem if you are the CPF Board.

If you choose to invest in the GIC, two things you need to think about. First there is a risk. It may be a slight risk, but it is a risk nonetheless. The problem with risk is that in the long term, if you invest correctly, it should all work out right. But in the short term anything can happen. Timing is everything.

For example, you invest in a "safe" stock which grows steadily in value, but just before you decide to cash out, there is a market crash which wipes out 20% of your value. And you are back (almost) to where you started. But crashes tend to work themselves out in a few weeks or a few months. So if you can wait, all will be fine in say... 2 years. BUT... you need your money now. When the stocks are down 20%.

That's the risk.

The GIC is a long-term investor (well, generally, because that makes the most sense) and they can afford to hold a position for a long time if necessary. But in the short term they may not be very liquid. So their bonds may be similar to the SSGS - non-tradeable.

But surely they can make it tradeable. Like the SGS:
SGS are marketable debt instruments issued for purposes of developing Singapore's debt markets. They provide a risk-free benchmark against which other risky market instruments are priced off. 
BUT, if the bonds sold to CPF members are tradeable, they would be subject to market rates and market forces in pricing. So say the prevailing interest (coupon rate)  on safe bonds (rated "AAA") is 4%;  that is, if you buy a bond with a value of $1000, you will get $40 every year. However, because CPF members have demanded higher interest rates, the SGS CPF bonds pays 6%. ($60 per year for $1000 bond).

And since the SGS CPF bond is tradeable on the open bond market, if the CPF member sells it, he would immediately get offers of about $1500. Because for that bond with that kind of risk rating and that coupon rate (6%), the market rate would be approx $1500 (because $60 coupon is about 4% of $1500). 

So in effect, by selling the high-interest bond to the CPF member at $1000, GIC is in effect selling subsidised bonds to the CPF member. 

And if the member choose to resell the bond immediately, he would get almost 50% gain. It's like if HDB sells you a BTO flat but does not impose the minimum occupancy period.

(Note: I'm over-simplifying here. A buyer would also be concerned about the remaining tenure of the bond, and the remaining coupons. A bond with 6% coupons at the 1st year of a 30 year bond, is valued differently from the same bond at it's 29th year. Also 4% for a low risk bond? Unrealistic in today's market. Today for low risk investments, you would be hard pressed to get even 1%. To get 4%, you would have to invest in higher risk instruments).

So why don't the GIC issue such bonds. At a subsidised rate, CPF members can immediately cash in and sell the bonds and get a windfall from realising the subsidy. There would be no cost to the Govt as the buyers of the bond will be the ones actually subsidising or funding the retirement of the CPF members.

Good, right?

Selling GIC bonds is like printing money, man!


I am not a financial/investment or legal expert, so I do not know if there is something financially or legally wrong about it. Especially the part about "printing money." So here are some speculations, questions, and concerns.

1. If the market rate is 4% coupon, issuing 6% (or a higher than market rate) means that the GIC is paying a premium to borrow money. This is not good business.

2. If the GIC gluts the market (and it is likely as CPF members have about $160b in their OA and SA as at Mar 2014), with bonds, how will it affect other bonds?

3.  Is there a diminishing return on investments? If GIC can find $200b worth of good investments with an average ROI of say 20%, does that mean that they can find $400b? Or $600b? Or will the ROI diminish? The first $200b can average 20% returns. but the next $200b only average 14%, and the $200b after that gets about 7%...

4. "Printing Money" was what the US did under the term "Quantitative Easing". Selling subsidised bonds seems to me to be in effect trading on our future. Bringing forward future value to spend today. This impoverishes the future (i.e. our children), and raises inflation today.

5. What is the evidence that the GIC is generating HUGE returns? As I delved into this issue, I found the GIC report, and unless someone can prove that the report is fraudulent, it is NOT generating enormous returns. The reported returns over 20 years was 6.5% in USD. If the GIC is average 6.5% in returns over the long term (20 years) can they afford to issue bonds with 6% coupon rates? I don't think so.

Here's the answer on the MOF FAQ on the GIC performance:

GIC’s mandate is to achieve good long-term returns, to preserve and enhance the international purchasing power of Government reserves. As a rule, GIC’s investments are outside Singapore and not in Singapore companies or instruments.
GIC publishes an annual report on the performance of the Government’s portfolio. The information below is extracted from its latest annual report (“Report on the Management of the Government’s Portfolio for the Year 2012/13”, released on 2 August 2013).
The annualised 20-year real rate of return, in excess of global inflation, as of 31 March 2013, was 4.0%. The 20-year annualised real rate of return metric is the key focus for GIC, which matches its mandate and investment horizon. A 20-year period is appropriate as it spans a few business cycles and hence encompasses a number of market peaks and troughs.
GIC also discloses the nominal rates of return over 5-year, 10-year and 20-year periods. These time frames give a sense of the ongoing performance of the portfolio. The 5-year and 10-year rates of return reflect an intermediate measure of GIC’s longer term performance.
The table below shows the portfolio's annualised nominal rates of return over the 5-year, 10-year and 20-year periods in USD terms, alongside a “65:35 global portfolio” which is included for 4. The table also shows the portfolio returns in the context of risk, as defined as the annualised standard deviation of monthly returns. GIC’s annualised 20-year return at 6.5% in USD terms was lower than that for the 65:35 global portfolio at 7.2%. This reflects the fact that GIC’s asset allocation until 10 years ago had a much lower risk profile than a 65:35 global portfolio. Over the last 10 years, GIC’s performance at 8.8% in USD terms had been comparable to the 65:35 global portfolio which returned 8.6%. GIC’s performance over the period had been helped by its investments in public emerging markets and alternative asset classes. 

Over the shorter term of five years, GIC’s return was 2.6% in USD terms, lower than the 65:35 global portfolio return of 3.4%. GIC’s performance over this period, like that of many long term-oriented institutional investors, had been affected by the weaker performance of alternative asset classes like real estate and infrastructure, which were slower to recover after the 2008/09 Global Financial Crisis. GIC’s public market investments performed comparably with the 65:35 global portfolio.
For all three time periods, the GIC Portfolio was less volatile than the 65:35 global portfolio.

If the above is true, investing in GIC is not going to result in fantastic returns. 

The truth is, Investment is an art, a risk, and most of the time, a gamble. There is NO sure way to get rich quick. The quicker the way, the higher the risks.

This picture below is closer to the reality:

The SG govt gives the GIC funds to manage. The GIC has strict directives (read their annual report on their portfolio management.) As the fund manager, GIC makes investments based on their assessment of risks and returns. As with any investment, some risks will not manifest, but some will. In some cases, unanticipated events may torpedo investments leading to loss or negative returns. But in the long term the returns average out to about 6.5% 

If that is the true GIC returns, the 4% and 2.5% that the CPF members are getting are reasonable. In fact, more than reasonable.

If you were in charge...

This is a simplified scenario or simulation. Let's say you are in charge of the CPF - running the CPF board and being responsible for the CPF members account, and the interests accruing to them.

The CPF members have savings in Special Acct and Ordinary Acct. You have to provide 4% interest for the SA, and 2.5% interest for the OA. This is the law. For simplicity, we will assume that the SA includes the Medisave account, or assume that there is no medisave account.

The SA are long-term secure funds (they can't withdraw until they are 65) which you can invest in longer term securities or bonds. For the OA funds, which members occasionally will withdraw for use to pay their mortgages or other purposes, you have to leave it more liquid. So these sums cannot be committed to as long a term as SA.

In banking terms, the cash-reserve ratio for OA will probably be higher than SA, in order to ensure sufficient liquidity to service OA withdrawals. (If there were an MA, the cash reserves ratio for that would be higher than the SA, but lower than the OA.)

To keep things simple, let's say SSGS offers only 10 year bond at 4% interest. You invest ALL the SA funds into this bond, and get 4% interest (This is risky, but for the purpose of this example, we'll let it go. it is risky because you have assumed that no CPF member will retire in the next 10 years and need the SA. We'll keep things simple and assume that  that is true. No one retires for the next 10 years.)

You still have OA funds but you need to keep some cash on hand to service the needs or demands of members (e.g. housing loan payments). So you invest 90% of the OA funds into the same SSGS bonds. You have, in effect, implemented a 10% reserve ratio. 10% of the OA money is earning NO INTEREST as it waits to be withdrawn by members. HOWEVER, you have promised members that they would get 2.5% anyway.

But this is fine. You are earning 4% on 90% of the OA, so you should be able to pay 2.5% on 100% of the funds in the OA and still have some leftover to pay administrative costs.

So to summarise, you would invest all the SA money in SSGS and get 4% interest, which you would then pay out to the CPF member. So there is no "profit" from the SA accounts.

For the OA, assuming a 10% reserve ratio, you invest 90% of your OA in SSGS getting 4% interest, you actually get only 3.6% (because 10% is not invested and does not earn interest). You pay 2.5% on ALL OA balances, and you have about 1.1% interest earned to pay for operating and administrative costs - like running CPF offices, paying salaries of CPF staff, utilities, etc. To keep things simple, let's assume that this 1.1% "surplus" is sufficient to cover the costs of running the CPF. (It would be a little more than 1.1% as members draw down on their balances and forego the interest, but again, let's keep things simple.)

So this is how it works.

Could it work any other way?

Of course!

No SSGS - What if there were NO SSGS bonds for CPF to invest in?

How do other pension funds make money for their members? Well, many do the same as CPF - invest in govt-backed investment instruments. If such instruments exists or are provided expressly for this purpose.

Others invest in the open market (for investment). With all the attendant risks.

The investment market works like any open market. Safe investments offer low interests, because they are safe, and many investors would like to invest in them because they are assured of their capital and their returns. As such these investments are under no pressure to offer better rates. Ergo, investments that offer higher interests are those that are deemed more risky.

The US Federal Reserve has held interests rates low (practically zero) since 2008, and the assessment of returns on investment in 2013 was pessimistic:
A “high yield” money market account pays less than 1% these days. No problem, you say, I’ll buy a CD. Well, that’s going to pay 2% or less right now.
These are "safe" investment - govt bonds and such. If you want higher returns, you will need to invest in riskier instruments. Not so safe. The GIC & SSGS bond arrangement evens out fluctuations from year to year. Otherwise, your CPF interest rates will vary from year to year or even quarter to quarter.
D1. What these investment arrangements mean is that CPF members bear no investment risk at all in their CPF balances. Their monies are safe, and the returns they have been promised are guaranteed. Neither does CPFB bear any risk, regardless of whether GIC’s investments earn or lose money in any particular year. The risk is wholly borne by the Government, on its own balance sheet.
D2. The Government pools the proceeds from SSGS with its other assets, and invests long-term funds through the GIC. The GIC does not in fact manage SSGS monies on their own, separate from the Government’s other assets. This is an important distinction, which I will come to later. GIC is fund manager for the Government, not owner of the assets and liabilities. It seeks to achieve the Government’s mandate of achieving good long-term returns, without regard to the sources of the funds that the Government places with it – for example, whether they are proceeds from SGS, SSGS or government surpluses.
D3. Over the long term, our investments in GIC have earned a creditable return. For example, over the last 20 years, GIC earned 6.5% per annum in USD terms, which translates to 5.0% per annum when expressed in SGD.
D4. But that is not the whole story. This average long term return masks wide fluctuations in returns from year to year. To answer Mr Gerald Giam’s question, over the last 20 years, there were 8 years where GIC’s investment returns were below what the Government pays on SSGS.
Pension Plans in search of greater and greater returns ended up investing in highly risky instruments like Collateralised Debt Obligations, or CDOs. Then the financial market crashed in 2008, and trillions of dollars were wiped out and pension and retirement plans payouts to their pensioners were severely reduced because the funds lost money.

If there is a moral to the above, it is that there is no easy money.

High interest? Comes with high risks.

Safe investment? Low interest.

People who tell you GIC is doing very well and can pay more interests? Selective reading - they pick the good years when GIC did well, and ignore those years when they didn't do so well.

CPF is cheap money for GIC to borrow cheap and make huge returns? 4% is not cheap. 2.5% is not cheap. If you have a loan for a mortgage (commercial) what is the interest rate? That's closer to market rate. Why is the market rate so low? For that you have to go back to 2008, the financial Crisis and the US Federal Reserve setting interest rate to 0% in order to stimulate the economy.

Other CPF related blog posts:

How I learn to stop worrying and to love the Minimum Sum.

Conservative Thoughts on Investment.

Can you meet your Minimum Sum?


Posts like this attracts comments from goddamn investment advisors - professionals and amateurs. So I am closing comments on this for the following reasons.

1) Goddamn Investment Advisors (GDIA) will firstly ignore the fact the CPF is NOT an investment and will suggest ways to invest your CPF. There is a reason for this. It is the same reason old people (over 55) going to the banks to put their CPF in Fixed Deposit often end up with investment products they had no intention of buying and have no understanding of what they had just bought. Meanwhile the fresh engineering grad who could not get a job as an engineer so ended up as an investment sales executive with the bank has just made his first sale... to a post-55 year old who doesn't need what he just sold.

2) GDIA will also tell you that CPF and Govt bonds are NOT completely risk free, and "GUARANTEE" may not mean what you think it means. This is all intended to frighten you into doing something stupid. Hopefully so the GDIA can benefit from your fear and fear-driven stupidity. Basically, they are sort of lying. Yes, it is absolutely true that NOTHING is risk-free. But in a world where nothing is risk-free, CPF is very nearly there. Yes the CPF system CAN fail. If Singapore fails as well. And yes, Singapore can fail. And if Singapore fails, we will have a lot of other problems. I remember when I was being sold an insurance policy from AIA and I already had one with NTUC Income. The sales pitch for AIA is that it is an International company, so even if SG fails, AIA will still be there. This is not exactly true, but not exactly false. The truth is that how things will turn out will depend on the specific nature of the disaster and you can't really anticipate that at all. The financial crisis of 2008 saw AIG faltering and in danger of collapse (bankruptcy). Here is a summary (link). That suggests two things. Maybe it won't be SG that fails. And even if NTUC Income fails, maybe (just maybe) the SG Govt will step in to save the company. If it is too big to fail. It may not be. The point is, the best laid plans may still lay an egg. Or you might get an omelette.

3) GDIA are trying to sell you hope and security. And for that they need you to be scared and worried. No matter how your situation is. And really, no matter how your situation is, there is always something else to worry about. If you can't find something to worry about, you are obviously not thinking hard enough. Maybe you can get a GDIA to advise you.

But seriously, thinking about investment? Here's my thoughts on it.

When I was younger, I thought of investing. But looking at my resources then, my instinct was, I don't have enough to invest. So I didn't.

But meet a GDIA and they will tell you that no sum is too small. You can invest with as little as a few hundred dollars.

Sure you can.

And the GDIA will be helping you.

And earning a commission.

Meanwhile, your "investment" will rise or fall and you will bear the risks.

I'm not saying don't invest. You have to decide. Based on where you are in your life, and your circumstances. And you need a plan. And you need to stick to the plan.

My opinion on investment are:

1) Investment is Gambling. But socially acceptable.
2) And because it is Gambling, gamble only what you can afford to lose. Most investors are gambling - sorry, "investing" - money they cannot afford to lose.
3) GDIA will tell you that it is never too late to start planning your retirement. They are lying. This is a classic line to separate the Post-55 from their CPF. In fact I would like a law that prevents GDIA from selling investment products to Post-55. Anyone who does so will be deemed to be defrauding an elderly, and he will have to prove that he is not. Why do they target the post-55? The same reason foreign brides target post-55 SG men: they have withdrawn their CPF.
4) Investment is not for wealth-creation, it is for wealth protection. If you can create wealth solely from investment, you should quit your job. Most people can't. Are there people who can? Sure. Just as there are people who can play games for a living, or make a living from singing, dancing, acting. They may be incredibly talented. Or incredibly lucky. If you have a few million dollars, or more, you need to invest or inflation will chip away at your wealth. If you are like me and do not have a million dollars (or even half a million) sitting in a bank account, inflation's effect on your idle money is not something we need to worry about. That $50k in your bank? That's not idle money. That's your contingency plan/reserve.

But of course different people have different threshold for "idle money". For me less than $500k is not worth investing. For another, $20k is just waiting to be invested.

For me, I have found that I am very risk-adverse. CPF is good enough for me. For others, maybe they feel that CPF returns are not exciting enough. They want their money back so they can invest and be able to run for election before they are 35, and slander the PM on the side.

Whatever turns you on.

The point of this post is to explain how CPF works. Knowing how it works, you can then decide if it is truly low-risk or even (very nearly) risk free.

If you still want your CPF back because there is a woman in Batam or in Hanoi you want to marry... good luck.

1 comment:

Wasserstein said...
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