MM Lee on the CPF

In today's Straits Times, MM Lee Kuan Yew was quoted as saying the following:

MM warns of 'dark side' despite economic boom

'We never invested the CPF money in shares or bonds. We always invested the CPF money in Singapore Government bonds where the Singapore Government guarantees a fixed return and you're always going to get it,' said Mr Lee, who is the GIC chairman.

'In other words, you will never lose. And if anybody thinks he can do better, he's welcome to take his money and go to a fund manager and try and do better.

Allow me to take issue with these statements on several counts.

MM Lee is claiming that the best possible return for one's retirement savings is a 3.5% risk-free return. i.e. he is saying that it is unwise for people to invest their monies in assets other than SGS bonds, and that equities, real estate and other investments are bad.

Well, I think that for anybody who has any basic understanding of investments, the absurdity of this claim is clear. In fact, I can just fly southeast to Australia and I can open a bank account and get 5.5% return risk free on Aussie dollar deposits. Plus, the Aussie dollar is appreciating against the Singapore dollar so I would get the benefit of the currency appreciation. On top of that, I get to withdraw the money when I need it, in case of emergency. Furthermore, I dare say that the Aussie economy is more resilient than the Singapore economy.

The 3.5% return on my CPF gives me none of these benefits.

In any case, even if people want to invest in risky assets for the benefit of greater return, I do not see why this is a worse alternative to leaving your money in fixed-return securities. In fact, it is widely regarded that a long term investment in the stock indexes is far superior to bonds. Just ask Jeremy Siegel, or Burton Malkiel, or any other expert on investment economics. It is disappointing to hear MM Lee, chairman of GIC, make such ill-informed statements.

Finally, yes, I think I can do better than SGS bonds. And yes, I would like to take my CPF monies and manage it myself. However, MM Lee, his son, and his cabinet have made the CPF compulsory by law. Yet he dares to say,

And if anybody thinks he can do better, he's welcome to take his money and go to a fund manager and try and do better.

MM Lee challenges us to find a more competent fund manager without allowing us the option to withdraw our CPF monies. That's like shackling a person's hands and challenging him to a boxing match. Not only is this statement hypocritical, it is cowardly and tantamount to hitting below the belt.

Well, well, MM Lee, if you really think you are so good at managing people's retirement savings, then I challenge you and your cabinet to make the CPF optional and allow Singaporeans the choice of withdrawing their CPF monies for their own management. If you are really as good as you claim, then people will naturally choose the government to manage their savings over alternative fund managers.

And if you're not willing to liberalise the CPF, I suggest you make less of such bold statements.
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Update: See "The Mathematics of Pension Fund Returns" by Lucky Tan for more on this issue.

Govt Investment De-linked from CPF funds?

In the ST Forum letter appended below, Jacqualine Poh, an executive from the Ministry of Finance, says that the CPF funds are invested in government securities, of which the proceeds go to fund part of Temasek's and GIC's investment activities. Ms Poh calls this "complete de-linking."

Secondly, Ms Poh says that the government is not using CPF as a cheap source of funds because "the Government does not need more funds to invest. Even if it did, it could raise funds more cheaply by issuing treasury bills and government securities, instead of using CPF funds."

Thirdly, she says that "we cannot assume that GIC and Temasek will do as well in future. The past two decades have been an exceptional period for global financial markets. Looking ahead, we cannot rule out protracted market downturns, lasting several years. Most CPF members have small balances and will not welcome these risks. "

Fourthly, Ms Poh says that Temasek's & GIC's returns above the CPF interest rate is not 'earning a spread at the people's expense.' She claims that what the government earns above the CPF interest rate is used for the benefit of the people through the annual government budget.

Well, issuing bonds to the CPF is not 'complete de-linking.' The risk of government default, however small, still exists. CPF members' returns are intrinsically linked to the stability of the Singapore government.

Also, implicit in the current structure of the CPF is the assumption that Singaporeans want to invest their pension monies in government securities. In other words, the government has IMPOSED on Singaporeans that their CPF monies have to go towards purchasing the government securities. The CPF may not be a 'cheap source of funds,' but it is an IMPOSED source of funds. Singaporeans' CPF savings are wrested from them by the force of law into the hands of government and its investment bodies.

Ms Poh also assumes that everyone would automatically choose the fixed-rate interest on their CPF funds. And then she extrapolates that because the majority would choose this, therefore everyone else has to accept the same fate. Talk about the tyranny of the majority. Or maybe it's the tyranny of the handful in power.

Finally, again she assumes that Singaporeans want the spread on the returns to be given back to them through the annual budget, at the government's whim and fancy. Well guess what, Ms Poh, I want my pension returns to be the way I want it. Not the way you and your ministry deem right.

The CPF issue is simple. It's about who retains the power to manage the people's savings. And why should it be the government's by default? Who gives them the right to say what should and should not be done with our pension money?

If Singaporeans don't stand up for their rights to decide how their savings should be managed, then the government will take it from them with glee.

read more about this issue here.

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GOVT INVESTMENT DE-LINKED FROM CPF FUNDS

IN 'CPF finances: Clarity needed to clear the cloud of confusion' (ST, Sept 20), Ms Chua Mui Hoong questioned whether the CPF provides a cheap source of funds for the Government's investments. Subsequent Forum letters also raised the matter of how the return on CPF funds is calculated, and what constitutes a fair return.

The interest members receive for their CPF money should reflect what they could earn by investing in the financial markets, in investments which have comparable risk and duration. All CPF balances are guaranteed by the Government and hence free of risk. Hence the Special, Medisave and Retirement Account (SMRA) interest rates will now be pegged to long-term government-bond yields. Furthermore, the first $60,000 of each person's CPF balances, to be held for the long term, will attract an extra 1 percentage point in interest. This means that they will always earn at least 3.5 per cent interest.

No commercial bank or fund manager offers more generous terms on such investments. Members seeking higher returns can take out their funds to invest through the CPF Investment Scheme (CPFIS). However, 83 per cent of CPF members who invested their OA savings in the CPFIS from 2002 to 2006 realised less than 2.5 per cent returns - the base rate of the OA. Half of all members who invested experienced negative returns, losing some part of their capital sum.

The CPF Board invests members' savings in special securities issued by the Government, which pay the CPF Board the same interest rates that its members receive. The Government pools the proceeds from issuing these securities with the rest of its funds, and invests them professionally for long-term returns. This is completely de-linked from the CPF Board and CPF members. Were this not so, CPF members would be exposed to the investment risks and could not receive guaranteed minimum interest rates.

Up to now, both GIC and Temasek Holdings have earned returns that exceeded CPF interest rates, on average over the years. But this does not mean that the Government is making use of the CPF as a 'cheap source of funds', or earning a 'spread at people's expense'.

First, the Government does not need more funds to invest. Even if it did, it could raise funds more cheaply by issuing treasury bills and government securities, instead of using CPF funds.
Second, Temasek and GIC achieve higher returns on average only by taking on more investment risks. Hence these returns are volatile - they can be low or even negative in some years. Furthermore, we cannot assume that GIC and Temasek will do as well in future. The past two decades have been an exceptional period for global financial markets. Looking ahead, we cannot rule out protracted market downturns, lasting several years. Most CPF members have small balances and will not welcome these risks. Neither will older members waiting to withdraw their retirement funds.

Third, Singaporeans benefit when GIC and Temasek investments do well. Every year, the Government draws part of these investment returns to fund the annual Budget. The revenue is spent on worthwhile investments and social needs, including subsidies for housing, education and health care. And from time to time, the Government distributes accumulated budget surpluses to citizens through CPF top-ups and other schemes.

The Government does not rule out the possibility of introducing private pension plans for those with balances above $60,000 and a higher capacity to take risk. However, it would be unwise for members with low balances to take excessive risks on their basic retirement savings.
The current arrangement thus enables all CPF members to earn fair and risk-free returns on their retirement savings, while benefiting from the good performance of GIC and Temasek through the annual Budget. This is the right way to help Singaporeans save for their old age, and enjoy peace of mind in their golden years.

JACQUELINE POH
DIRECTOR (SPECIAL DUTIES)
MINISTRY OF FINANCE
29 September 2007

The Economics and Politics of the CPF

[What follows is the excerpt of an exchange I had with someone regarding the CPF. My opinions are purely my personal comments and should be read in the light that I do not have empirical data and am only able to speculate about how the CPF is managed.]

Q: Whats your opinion about CPF 2.5 % and 4 % per annum? Are the returns fair for the avg singaporeans? I thought CPF as an institution ($60 bn, correct me if i'm wrong), should have economies of scale when engaging with investment banks and hence better returns if it were to engage with Vanguard or Merrill Lynch.

...

I think the real question for CPF should always be about economic/financial viability and nothing to do with politics. Investment is something we can calculate/evaluate that is why i love it, can we evaluate politics?

A:The Ministry of Finance (MoF) manages and controls the CPF. It takes in monies/deposits from Singaporeans on the liabilities side while investing the proceeds on the assets side.

On the assets side, Temasek and GIC, which are owned by the ministry of finance, manage the reserves and investments of the MoF.

Now, the challenge for the ministry of finance is to give Singaporeans a reasonable return on their CPF monies, at the same time guaranteeing that
A. it will be there for their retirement, and also guaranteeing that
B. it will be available for housing and medisave,
as and when it is needed for those purposes.

The crux is, how much return should Singaporeans get on their CPF savings, while still being able to retain benefits (A.) and (B.)

Your contention is that it should be possible for the government to give a higher return than a 4% fixed rate. After all, if you were just managing your own retirement money, you would just put your savings into an index fund and let it sit for 30yrs and you would expect to earn about 9% per annum. So, why can't the government do this, since because of its size it has a large bargaining power and it can rope in world class investment expertise from around the world?

My argument is that, yes, it may be possible for the government to give higher rates, but with several caveats.

a. Size is the enemy of returns. Even the Sage of Omaha, Warren Buffett, has admitted that the mountain of capital he has to deploy eats away at his returns. On an individual's scale, you may be managing your retirement money of $1 million. However, this is a very different problem compared to managing assets of $60b. The MoF/CPF cannot simply stick all its assets into an index fund like you can. We have to note that from the government's point of view it is taking responsibility for the entire country and the problems are quite different on a macro scale rather than the micro scale of the individual.

b. Many Singaporeans intend to use their CPF for housing and Medisave. This adds a liquidity challenge to the investment issue and the government may only be able to deal with this by devoting a significant portion to shorter-term marketable liquid securities which give a much lower return than equities. At the same time, higher returns tend to be made in long term investments such as corporate acquisitions, real estate, and equities which will be much more volatile and illiquid than fixed-income securities. Therefore, in order to provide the liquidity and certainty (benefits A. and B. as discussed above), the Ministry of finance may not be able to devote a large portion of CPF monies into higher yielding investments, therefore the tradeoff is that Singaporeans have to accept lower returns on their CPF monies than if they were managing their retirement themselves.

Since we do not have empirical information about the size of the CPF and the inflows and outflows of CPF monies and the investments of the MoF, we can only speculate whether or not 4% is a reasonable number.

This covers the economics and finance of the CPF issue.

The politics of the CPF, however, is just as important.

Central to the CPF is the idea that Singaporeans should automatically abdicate their rights (and responsibilities) to manage their own retirement money, to the government. This is enshrined in the fact that CPF is compulsory for all Singaporeans.

If Singaporeans accept the compulsory nature of the CPF and take no political action to the contrary, then they have to also accept whatever it is that the government gives them. After all, if you don't want to take responsibility for your own retirement, then you have no say in determining the return on your retirement monies. In other words, if you let the govt manage your money, then you have to accept whatever the govt gives you, 4% or not.

And, if the govt is able to invest the money at 15% (thru its investment arm like Temasek) but it only gives you 4% per annum, it may be earning the spread of 11%. You may be unhappy with the fact that the government is getting in a sense a low interest 'loan' to make its investments, but the fact is that Singaporeans as a whole keep quiet and do nothing to change the status quo.

Now, you might say, many people do not have time to look after their savings investments and are willing to let someone else who knows what they are doing, manage it for them.

How about those who have the time to manage their investments? Perhaps an option is to make the CPF an optional scheme. For those who want to opt into CPF, the government will be responsible. For those who want to opt out, they will have to be responsible for their own retirement. But this is a political issue.

Or perhaps, we could retain the compulsory nature of the CPF, but instead of forcing Singaporeans to contribute 20% of their salaries, they should only be required to contribute less, like maybe 10%. This is a number that is closer to other countries' pension funds, like the Canada Pension Plan. This, again, is a political issue.

We could even ask another question and say, I'm not sure that the CPF is giving me as much money as I should be getting. I think the government should be more transparent about the CPF and the returns it is getting so we can figure out if we deserve more. But transparency is a political issue.

The issue about how much returns can the government give on our CPF monies is a economic issue. But the question, should CPF be compulsory and/or should we have the freedom to manage more of our retirement monies and give less to the CPF, is a political one. The question whether the govt should be transparent with their books, is a political one.

And as long as the politics of the CPF remains as it currently is, there is no point arguing that the government should be giving more than 4%. Because as long as Singaporeans abdicate their rights to manage their own retirement money, the returns on the CPF are not for the people to decide, it is for the government to decide.

I think the real issue ultimately boils down to whether the people want to be spoon fed and let the govt take the responsibility for their retirement, or they want to take responsibility into their own hands. i.e. without solving the political issues of the CPF, it means very little to debate over the economic ones.

Compulsory Annuity Scheme: Around the Blogosphere

The compulsory annuity scheme tweak to the CPF system to deal with the aging population was recently announced by PM Lee Hsien Loong in his NDP Rally Speech 2007. It has drawn heated discussion from many quadrants of Singapore's society, not least in the blogosphere. Here is a collection of links on the subject:

My first link is that from Bart JP, who is pursuing his PhD in Economics in LSE and will be later joining the government as an Economist. I list his view at the top because it is one of the few voices openly lauding PM Lee's announcement to implement "longevity insurance."

• A Right Step Towards Risk Pooling
  from Perspective Unlimited

A second voice supporting the proposed compulsory annuity is that from Singapore Angle, by Teh Ci. He thinks that "the compulsory annuity is a good thing for Singaporeans."

• Good Compulsory Annuity, More Welfare?
  from Singapore Angle

The next is a balanced viewpoint from veteran journalist Seah Chiang Nee: "With the rising cost of living, senior citizens who have little education, money or family support are becoming the city state’s rising disenchanted."

• Old Age Not A Blessing
  from The Star by Seah Chiang Nee

The Online Citizen is sceptical about the proposed initiative, with couple of their writers having a go. Prolific writer Leong Sze Hian takes the opposition to Bart JP and engages the CPF system directly in three posts, all are definitely worth your time:

• Are there systemic problems in our CPF system?
  from theonlinecitizen
• Unanswered questions about CPF changes
  from theonlinecitizen
• Some concerns about annuities and tweaking the CPF
  from theonlinecitizen

From the same website, Andrew Loh compares the pension that ministers get in comparison to the plight of average Singaporeans.

• Annuities for Singaporeans, pension for ministers?
  from theonlinecitizen

The above discussions have been remarkably civil, let's get down to having more fun. Lucky Tan in his usual sarcastic style tells us why we should "[w]ork longer and harder..and ... help to solve the problem of ageing Singaporeans without burdening the PAP govt." Or should we?

• Wonderful brilliant scheme to help the extremely old....
  from Diary of A Singaporean Mind

Meanwhile, we can never ignore the father of the blogosphere, Mr Brown, as he gives his take in his Mr Brown Show.

• the mrbrown show: annuity schemes
  from the mrbrown show

But what does this issue really boil down to? Perhaps it is just the issue of whether the government should be deciding for us how we should deal with our retirement, or whether we should be left to our own devices to plan for our old age. While the annuity scheme might be a good idea in theoretical economics, forcing it down Singaporeans' throats is politically questionable. Aaron Ng articulates this idea quite nicely.

• “Coerced” annuity and possibly lesser returns on CPF
  from Hear ye! Hear ye!

The main ideas have been expressed above, but there are many other pieces of good commentary on the CPF system, the annuity proposal, and the aging population in general. Take your time to work through them:

• On CPF, Life, Work and Retirement
  from Mr Wang Says So
• PM Lee & The Aging Population
  from Mr Wang Says So
• CPF and its creaky assumptions
  from Yawning Bread
• The Great Annuity Scheme Diss
  from The Void Deck

Don't forget to visit Sei-ji Rakugaki, who has drawn a cartoon for us :)

• CPF overhaul after the national day rally
  from My sketchbook

Update: There has been talk of a planned organised silent protest on sometime soon! Things are getting exciting! Read more:

• Black Sheep
  from Sheep City
• Protest against annuities. Sept 8th, 2007 at 4.00...
  from Singapore Dissident

Goh Meng Seng has expressed his displeasure at the compulsory annuities:

• Say No to Compulsory Annuities
  from Singapore Alternatives

Note: This post will be updated as more content appears. Leave a comment if you think there is a good post that needs to be included

Disclaimer: I neither endorse nor oppose the proposed protest against the compulsory annuities.