2econdsight

"to rescue truth from beauty and meaning from belief"

CPF Revamp : Investment Options

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I got to know Chris thro’ TRE. After exchanging some comments, we got in touch and met up back in Feb, I think, when he came by Singapore from Tokyo. Since then, we have exchanged more ideas and thoughts. Below is the 2nd collaboration we did for TRE.

He is the brain behind the piece written. I know only so little about matters financial. So, I merely ‘ride’ along for the credit…

[Editor’s Note: The following article was submitted to TRE for publication on Thursday, 29 May i.e. before ST came up with their own 3-point wish list under Politics 360 on 31 May.]

This article, the first of 2, outlines proposals to revamp CPF with the objective of improving returns. The second, shorter article, deals with Withdrawals and Medisave. Some aspects of what is proposed may come across as controversial to Singaporeans but the objective is to stimulate discussion and debate of that which rightly belongs to the citizens must yield a fair return for retirement and healthcare funding.

Low Returns on CPF and savings

As a preamble, it is useful to understand that the monetary policy framework and the fiscal strategy of persistent budget surplus conspire to generate low rate of returns on not only CPF but also personal savings. These arrangements had the result of favouring the corporate sector with low cost of capital at the expense of citizens’ savings. Moreover, the government controls CPF rates by administrative fiat but like to make reference to market yields as if the dynamics of the market have not been affected by those policies to produce the desired outcome for the government. This provides a powerful tool to set CPF rates against prevailing inflation to deliver additional surpluses. Through the Net Investment Return Contribution (NIRC) framework, the government has an inherent bias towards low CPF rates as the resulting low government debt servicing means higher sums for discretionary spending.

Proposed changes to CPF Returns

To improve returns on CPF, the authors seek to modify the setting of CPF rates from administrative fiat to one decided by inflation or actual market based returns. Here is a choice of 3 proposals with the simplification of 1 rate for all accounts (no distinction between OA, SA, MS, RA for transparency).

Option A: Inflation indexation of CPF rates

All CPF accounts to be indexed to the inflation rate by having the interest rate priced at a spread over the inflation rate. The authors propose using the long run 2% average inflation premium of the 30 year inflation-indexed bonds of the major issuers such as Australia, Canada, Germany and the US. The following table gives an overview of what inflation-indexed CPF rates would have been in the past 7 years against what CPF members actually received by government decree.

  2007 2008 2009 2010 2011 2012 2013 Ave
Inflation 2.1 6.5 0.6 2.8 5.3 4.5 2.4 3.5
Ave CPF Rates 3.3 3.4 3.4 3.4 3.4 3.4 3.4 3.4
Indexed Rates 4.1 8.5 4.6 6.8 7.3 6.5 4.4 5.4

In 2013, inflation indexation would mean that an extra $5.2b interest will be taken from the investment returns of reserves. Each CPF account would have gained an average of $1,480.

Advantage: This counters the effect of inflation, is transparent and does not require CPF members to make investment decisions. It is simplest to enact since it is a matter of changing the current interest rates of the Special Singapore Government Securities (SSGS) to the above inflation-index method. The
government continues to guarantee principal and interest because CPF continues to invest in SSGS.

Disadvantage: In times of low inflation, the interest rates will be low but remain above inflation.

Option B: Rates linked to GIC or Temasek

This proposal converts CPF into an actively managed fund whose rate of return is generated either by GIC or Temasek. This will necessitate CPF to invest directly in the selected entity to ensure legal claims to its returns. This makes redundant the present investment in SSGS which is the legal barrier preventing CPF from receiving the full returns. The selection should be based on accepted risk tolerance: lower risk / lower return GIC or higher risk / higher return Temasek. Historical returns below.

  GIC Temasek
Reported 10 year returns 5.3% 13%
(Temasek delivers net income, est. 7.5%)

*Temasek has the advantage of owning GLC assets, the most stable and valuable assets in its portfolio which gave CPF an exposure to Singapore which GIC does not.

Having made the selection, a necessary step will be to adjust the total amount of assets in the selected entity to the total amount of CPF liabilities plus a government-injected general reserve which includes CPF’s own operating surplus. The creation of the general reserves mitigates the end of the government
guarantee due to the redundancy of SSGS. This arrangement ensures CPF ownership of the assets in the selected entity and have full claim on the returns while enjoying risk mitigation from the general reserves. The selected entity manages the CPF funds and the general reserves as a single pool.

The other entity remains a Sovereign Wealth Fund providing a clear separation of CPF assets and sovereign assets for full transparency, a complete and necessary departure from the present obfuscation. The selected entity should be subject to quarterly review by the Ministry of Finance and CPF, semi-annual testimony to a Parliamentary select committee and annual public audit.

Advantage: Similar to the Option A, CPF members are not required to make investment decision. Returns can be higher than Option A.

Disadvantage: In times of poor investment performance, returns can be less than Option A or may even suffer losses but this is mitigated to a large extent by the general reserves,

Option C: CPF Member Self Investment

The final proposal is to allow CPF members to self-invest up to 50% of their CPF accounts. The self-invest portion will be subject to much wider criteria than the present CPFIS, such as a wider range of investment choices including foreign investments under a specified maximum limit of exposure. The remainder of funds in CPF will be subject to Proposal A or Proposal B. This proposal requires CPF members to make investment decisions on their self-invested portion and should do so under advice from professional pension advisors. CPF members may choose not to self-invest at all.

Advantage: Combined returns can be higher than Option A or B.

Disadvantage: Poor investment choices and market down turns can cause returns to be lower than Option A and B due to the lack of general reserves against losses in the self-invested portion.

No chance of Happening

The proposed options are radical requiring wholesale changes to the debt management dynamics of the government. Aside from showing the government has been less than forthright with citizens in regards to the effectiveness of the present CPF format if the suggested options are effected, there are also 4
significant if indirect impact;

1. CPF will no longer be captive to the government’s persistent arrangement of the SSGS/ bond market within the monetary policy framework to deliver low financing costs to the corporate sector at the expense of citizen’s savings.

2.  The government can no longer use a high inflation – low CPF interest servicing equation to deliver benefits to its budget at the expense of CPF savings’ future purchasing value being eroded by recent low, at times negative real CPF rates of return.

3.  The government will also not be able to use low CPF rates to generate high NIRC for discretionary spending as they have done for the PG Package if and when they regard such spending serves a political purpose.

4.  CPF’s rate of return will be transparent. The present difference between CPF rates and returns generated from the reserves which include CPF funds will be eliminated or drastically reduced.

Hence the chance of any of the above happening under the present government will be zero. Is this fine with citizens? Or is it time that we deserve better returns to meet our retirement and healthcare needs?

Chris K / 2cents

* Chris K holds a senior position in a global financial centre bigger than Singapore. He writes mostly on economic and financial matters to highlight misconceptions of economic policy in Singapore.

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