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[h=2]CPF investment returns: Giving Singaporeans their due[/h]
May 19th, 2014 |
Author: Contributions
Over the past few years, a lot has been said about how CPF funds are managed. By now, most should be aware that the CPF Board does not do any investing of our CPF monies. Rather than take on the role of investment manager, it purchases Special Singapore Government Securities (SSGS) from the Monetary Authority of Singapore (MAS) to offload this task. CPF monies thus flow into the reserves to be managed by GIC and Temasek Holdings.
This mode of operation is fairly interesting. The terms of SSGS are the basis upon which the CPF Board pays Singaporeans interest on their CPF monies. It is clean, and also “essentially risk-free”. But therein, too, lies the rub. We know that GIC claims to be making 7% each year from investments (and Temasek 17%, but it has been claimed that Temasek does not manage CPF monies, so we focus on GIC). Presently, savings in Singaporeans’ CPF Special and Medisave Accounts (SMA) return the higher of 4% per annum or the 12-month average yield of 10-year Singapore Government Securities plus 1%, and Singaporeans’ CPF Ordinary Account (OA) monies return 2.5% per annum. GIC’s returns are much higher than the rates that are being paid out. Therefore, the question must be: Are Singaporeans getting a raw deal?
The Strawman Solution
The government might say that the above scenario reflects a fair trade of risk and reward. This is true to an extent. I imagine that the government would put forth the following hypothetical with the intent of demolishing it:
This is a bad solution, and I regard it as the “Strawman Solution” — Obvious, and obviously flawed.
A Viable Alternative?
Still, the picture painted by the statistics are rather clear. There are excess returns of at least 3% per annum on average. There is a sense in which a more equitable solution has to be arrived at. But we would like to (I would like to) restrict our attention to solutions where, barring a recession more chronic or severe than what we’ve seen in the past few decades, CPF balances only rise with time, at or beyond a base-line rate.
To achieve this, there has to be an intelligent way of giving back excess returns while making sure base-line returns (2.5% for the OA and 4% for the SMA) are still obtained in bad years. The obvious solution is to build up a “buffer” of excess returns. One might think of it as a storage tank. Each month, returns go first into building the “buffer” (filling the storage tank) and then being returned to CPF accounts. If base-line returns are not achieved, then the “buffer” (storage tank) is used to fund these returns.
Here are some examples of how things might work:
The question, then, would be how to size the “buffer”. Clearly one would like to be able to make pay outs even in a recession (especially in a recession) and also in the years of recovery that follow. Given that recessions can last about 2 years, and a recovery might take some time, one might want to size the “buffer” such that “a full tank” will be able to fund approximately 5 years of base-line returns. This might mean something on the order of about SGD 20 billion to SGD 30 billion. (Over time, we might even want to have a “10 year capacity tank”.) Another matter is how the “contents” of the “tank” should be invested. In relatively safe instruments like bonds?
If such a scheme were to be started today, how “full” would we be able to regard the “tank”? Unfortunately, from an accounting stand-point, the excess returns have “disappeared into the reserves” and are “irretrievable”. This is because the CPF has purchased the cash flows associated with SSGS, and these are registered as liabilities to MAS to be funded by the investment returns. Not a single dollar of the returns, or even the principal used for investment, is tagged “CPF Board”. Legally, it seems like the proposed “buffer” will have to be built from scratch.
Jeremy Chen
* The author blogs at Jeremy Chen’s Website.
Over the past few years, a lot has been said about how CPF funds are managed. By now, most should be aware that the CPF Board does not do any investing of our CPF monies. Rather than take on the role of investment manager, it purchases Special Singapore Government Securities (SSGS) from the Monetary Authority of Singapore (MAS) to offload this task. CPF monies thus flow into the reserves to be managed by GIC and Temasek Holdings.
This mode of operation is fairly interesting. The terms of SSGS are the basis upon which the CPF Board pays Singaporeans interest on their CPF monies. It is clean, and also “essentially risk-free”. But therein, too, lies the rub. We know that GIC claims to be making 7% each year from investments (and Temasek 17%, but it has been claimed that Temasek does not manage CPF monies, so we focus on GIC). Presently, savings in Singaporeans’ CPF Special and Medisave Accounts (SMA) return the higher of 4% per annum or the 12-month average yield of 10-year Singapore Government Securities plus 1%, and Singaporeans’ CPF Ordinary Account (OA) monies return 2.5% per annum. GIC’s returns are much higher than the rates that are being paid out. Therefore, the question must be: Are Singaporeans getting a raw deal?
The Strawman Solution
The government might say that the above scenario reflects a fair trade of risk and reward. This is true to an extent. I imagine that the government would put forth the following hypothetical with the intent of demolishing it:
Suppose, for instance, that MAS crafted a mutual fund that Singaporeans could instruct the CPF board to invest in (instead of in SSGS or along with SSGS). This would give the CPF funds of those Singaporeans exposure to the global financial market and to customized (non-mass market) instruments that only sovereign wealth funds and other large investors have access to. That fund might be managed by GIC and/or Temasek via “taking a stake” in GIC/Temasek portfolios. Singaporeans’ would then see their CPF monies fluctuate with the global market, surging in booms and plummeting with crashes.”
It is not clear that the majority of Singaporeans are ready for that kind of risk. In fact, it is clear to me that many Singaporeans recoil at the possibility of catastrophic loss, and no government wants to oversee a year where 40% of retirement savings evaporate.
This is a bad solution, and I regard it as the “Strawman Solution” — Obvious, and obviously flawed.
A Viable Alternative?
Still, the picture painted by the statistics are rather clear. There are excess returns of at least 3% per annum on average. There is a sense in which a more equitable solution has to be arrived at. But we would like to (I would like to) restrict our attention to solutions where, barring a recession more chronic or severe than what we’ve seen in the past few decades, CPF balances only rise with time, at or beyond a base-line rate.
To achieve this, there has to be an intelligent way of giving back excess returns while making sure base-line returns (2.5% for the OA and 4% for the SMA) are still obtained in bad years. The obvious solution is to build up a “buffer” of excess returns. One might think of it as a storage tank. Each month, returns go first into building the “buffer” (filling the storage tank) and then being returned to CPF accounts. If base-line returns are not achieved, then the “buffer” (storage tank) is used to fund these returns.
Here are some examples of how things might work:
The question, then, would be how to size the “buffer”. Clearly one would like to be able to make pay outs even in a recession (especially in a recession) and also in the years of recovery that follow. Given that recessions can last about 2 years, and a recovery might take some time, one might want to size the “buffer” such that “a full tank” will be able to fund approximately 5 years of base-line returns. This might mean something on the order of about SGD 20 billion to SGD 30 billion. (Over time, we might even want to have a “10 year capacity tank”.) Another matter is how the “contents” of the “tank” should be invested. In relatively safe instruments like bonds?
If such a scheme were to be started today, how “full” would we be able to regard the “tank”? Unfortunately, from an accounting stand-point, the excess returns have “disappeared into the reserves” and are “irretrievable”. This is because the CPF has purchased the cash flows associated with SSGS, and these are registered as liabilities to MAS to be funded by the investment returns. Not a single dollar of the returns, or even the principal used for investment, is tagged “CPF Board”. Legally, it seems like the proposed “buffer” will have to be built from scratch.
Jeremy Chen
* The author blogs at Jeremy Chen’s Website.
