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GIC Harvests Risk Premiums. Government Harvests CPF 


Malaysia’s EPF recently announced its latest dividend is 6.75%, which is over 3% higher
than those CPF received from the government. But this is not because EPF’s
investment performance is vastly superior to GIC. It is really all about who gets the
investment risk premium which a long term investor like EPF and GIC, to use the words
of the latter’s CIO Lim Chow Kiat, harvested from investing in risk assets.
What is the Risk Premium?

In simple term, the risk premium is the extra returns earned from investing in risky
assets over the risk-free rate which in practice refer to the government bond yield since
it is the safest instrument from the risk of default (but does not give assurance that the
risk free rate is enough to protect against other risks such as increases in cost of living).

It is compensation for tolerating risks. Here are 2 hypothetical investments

ITEM / PORTFOLIO TYPE Equity Portfolio High Yield Bond Portfolio
a. Actual Return 6.50% 5.00%
b. Risk Free Rate 2.50% 2.50%
c. Risk Premium (a-b) 4.00% 2.50%

Harvesting the Risk Premium
Because of mandatory contributions and legislated monopoly over management of
these funds, EPF and GIC, unlike the vast majority of asset managers, do not face
investor redemptions and are nearly assured of long term inflow of funds. Therefore they
can 1) endure market dislocations far better 2) take advantage when dislocations
caused prices to diverge significantly from underlying values and 3) be patient for
invested assets’ fundamental values to realise over the long term. These factors provide
the managers with long term orientation to harvest the risk premium over the investment

Who gets the Risk Premium?
The following table illustrates using the long term rolling returns in local currency of GIC and EPF,

ITEM / Provident Fund GIC EPF
a. Actual Return 5.40% 5.50%
b. Risk Free Rate 2.80% 3.80%
c. Risk Premium earned 2.60% 1.70%
d. Risk Premium paid to members 0.70% 1.60%
e. total paid to members (b+c) 3.50% 5.40%
f. Risk Premium retained 1.90% 0.10%

EPF’s return is only marginally better at 5.5% versus GIC’s 5.4%. This is entirely
explained by Malaysia’s higher risk free rate (due to its weaker sovereign credit) which
then required a higher return threshold from Malaysia stocks and bonds in EPF’s
portfolio . However, comparative investment performance needs to consider the
premium over the respective risk free rate which shows GIC is the superior manager
generating 2.6% over its risk free rate against EPF’s 1.7%.

But EPF paid out 1.6% risk premium on top of the Malaysian risk free rate to its
members an average all-in return of 5.4% while CPF only got 0.7% risk premium,
altogether 3.5%. Therefore, nearly three quarters of the risk premium harvested by GIC
was retained by the government.

How the Government harvests CPF
CPF is legally coerced into investing in only Special Singapore Government Securities
(SSGS). This provides 2 crucial benefit to the government;

a)CPF is removed from legal claims on returns generated by GIC since CPF monies
became debt proceeds rather than equity participation. Debt proceeds meant the
debt holder (CPF) is paid an interest by the debtor (the government). Equity
participation would have meant that the equity provider (CPF) has full claims on the
returns generated by the asset manager (GIC).
b)Make the government appear “generous” by paying rates higher than the prevailing
risk free rate (bond yields) when this is nothing more than minimal compensation to
members for an illiquid asset.

However a potential weakness is the construct of the SSGS which cannot really be
called securities if they are not negotiable and if the setting of interest rates is at the sole discretion of the issuer, the government. SSGS may not then be considered as bona
fide securities which in turn call into question if the government can avoid meeting
CPF’s claims on returns generated by GIC.

Should CPF Members want more?
Are CPF members better off if CPF has not invested in “risk free” SSGS but accept the
chance of potential losses by earning the rates of return GIC earned for the
government? The answer is a resounding yes and the evidence is in the chart given
below taken ironically from the GIC annual reports.

It provides the US$ real rate of return, i.e. the return in excess of a 2.5% inflation rate. In
S$, the real return will be approximately 1% lower. This evidenced that should CPF pay
out annual rates based on the average 20 year return earned by GIC,
1)it did not receive a single of year of loss despite the 20% plus loss in 2009 (and
recovery in 2010)
2)CPF members received annual rates of returns of over 5%, providing a far greater
cushion against the inflation rate and ancillary rises in cost of living.
3)More CPF members will meet the Minimum Sum
4)CPF members get larger income drawdown in retirement – the $155,000 Minimum
Sum providing $1,200 per month under the CPF LIFE Standard Plan under present
rates of return will be as much as $1,800.

Scaring Citizens with Risk
In a Parliamentary reply to the Workers Party, DPM Tharman said “In eight out of 20
years, GIC’s returns were lower than the rate promised to CPF members, but the
Government absorbed the losses”. But he conveniently failed to mention the average
rate of return over those 20 years were still much higher than rates promised to CPF
members. This is nothing more than to scare citizens into accepting low “risk free” CPF
returns and to paint the government as “generous”.

The narrative that CPF is “good return” and “immunizes CPF members from risk” is so
effective that most Singaporeans believe that it is entirely safe and appropriate that
mandatory savings invested in nothing else but“risk free” CPF throughout their entire
lives, blissfully ignorant it is not sufficient to compensate for large cost of living increases resulting from Singapore moving from developing to advanced economy.
In the meantime, this avoidance of risk gives the government the blank check to siphon
off large excess returns into the reserves which would have given CPF members better
provisions for their retirement and healthcare but which instead allows the government
to follow the path of least resistance in its policy choices than to face Hard Truths.

Chris Kuan


5 thoughts on “GIC Harvests Risk Premiums. Government Harvests CPF 

  1. I take issue with using “Risk Free Rate” in today’s environment when governments worldwide heavily manipulate interest rate. Many government bonds currently generate negative real returns (how is that “risk free”?).

    Interests paid by CPF over the last 20 years barely beat official inflation over the same period of time. Further, government inflation figures are fudged to be lower than what average citizens experience in real life. (E.g. housing prices/medical cost vs inflation anyone?)

    Singapore citizens must demand an independent CPF board that invests members’ savings and returns its earnings to all members, just like other pension institutions. A typical US pension fund returns 7-8% annually. Given the economic growth experienced in Singapore over past 30 years, a pension fund would have returned at least 7-8% annually in local currency during that timeframe as well. (Note that Temasek “claims” to earn an annual return of 16%!)

    Singapore is a weird country where such nonsense is accepted by its citizens.


    • Good point about what we CPFers deserve better of the PAP managing our blood-earned money for 50 continuous years.

      As for ‘risk free’, Chris is better poised to respond to you. I think it has to do with each one’s definition of “free”.


    • Hi the Risk Free Rate is a highly relevant factor in measuring rate of return. It is essentially a theoretic rate that is free from the risk of default. The closest proxy is the relevant govt bond yield. It does not mean it is free from other risks such as inflation which I explained in the article.

      Why is the risk free rate critically important? Simply it is the minimum rate one shud expect to achieve from a investment with low probability of default. Any acceptance of risk must therefore produce a return higher that the risk free rate to be a viable investment. Since each investment or each portfolio has different risk tolerance then the risk premium, the difference between the achieved rate of return and the risk free rate becomes important in measuring and comparing performance.


      • In a functioning economy, I would agree with you. However, today we are living in the era of QEs. When governments (e.g. EU) purchase nearly *all* of its newly issued bonds, its rates have no meaning. No private individuals would purchase such bonds, which sometimes yield negative return! These are no longer risk free rate. They are QE’d rate.


  2. Am afraid you may have understood the concept or the function of the Risk Free Rate. One needs to think of it as a minimum clearing rate for risk and this minimum clearing rate is not set in stone as it fluctuates according to the ebb and flow of the links between the economy and interest rates. Governments do not purchase their own debt – if they purchase all its newly issues bonds as you say then there is no increase in government indebtedness. It is the central bank that purchase these bonds and they are independent of the government. If the effect is negative interest rates then that is because there is deflation. In this day and time, we cannot think only of positive interest rates and inflation alone. The Japanese experience of the last 15 years told us to change our thinking.

    Now how does QE affect the risk free rate? But that question needs to go further as to how it affects the economy. QE lowers the Risk Free rate because the central bank purchases lots of government bonds which causes government bond yield, the closest proxy to the risk free rate to decline. That is one of the most important intended outcome of QE – that is to engineer a fall in the risk free rate so that the threshold by which companies and individuals risk their monies to generate a profit or a return is lowered. In a debt deflationary environment which we had seen since 2008, the risk aversion (avoidance of risk by companies and individuals) reinforces that environment, hence the term debt deflationary spiral or vortex. Greece is an example in extremis. The drastic lowering of risk free rate is to change the risk aversion psychology into risk reversion by lowering the risk reward threshold for companies and individuals to risk their monies to invest, a necessary precondition to break out of the debt deflationary spiral and get the economy moving.

    Call it QE’d rate is not far from the truth since QE drives down the risk free rate but that is the intention in a dangerously difficult economic environment.


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