Goldman Sachs Rakes In Profit in Credit Crisis - New York Times

For more than three months, as turmoil in the credit market has swept wildly through Wall Street, one mighty investment bank after another has been brought to its knees, leveled by multibillion-dollar blows to their bottom lines.

And then there is Goldman Sachs.

Rarely on Wall Street, where money travels in herds, has one firm gotten it so right when nearly everyone else was getting it so wrong. So far, three banking chief executives have been forced to resign after the debacle, and the pay for nearly all the survivors is expected to be cut deeply.

But for Goldman’s chief executive, Lloyd C. Blankfein, this is turning out to be a very good year. He will surely earn more than the $54.3 million he made last year. If he gets a 20 percent raise — in line with the growth of Goldman’s compensation pool — he will take home at least $65 million. Some expect his pay, which is directly tied to the firm’s performance, to climb as high as $75 million.

Goldman’s good fortune cannot be explained by luck alone. Late last year, as the markets roared along, David A. Viniar, Goldman’s chief financial officer, called a “mortgage risk” meeting in his meticulous 30th-floor office in Lower Manhattan.

At that point, the holdings of Goldman’s mortgage desk were down somewhat, but the notoriously nervous Mr. Viniar was worried about bigger problems. After reviewing the full portfolio with other executives, his message was clear: the bank should reduce its stockpile of mortgages and mortgage-related securities and buy expensive insurance as protection against further losses, a person briefed on the meeting said.

With its mix of swagger and contrary thinking, it was just the kind of bet that has long defined Goldman’s hard-nosed, go-it-alone style.

Most of the firm’s competitors, meanwhile, with the exception of the more specialized Lehman Brothers, appeared to barrel headlong into the mortgage markets. They kept packaging and trading complex securities for high fees without protecting themselves against the positions they were buying.

Even Goldman, which saw the problems coming, continued to package risky mortgages to sell to investors. Some of those investors took losses on those securities, while Goldman’s hedges were profitable.

When the credit markets seized up in late July, Goldman was in the enviable position of having offloaded the toxic products that Merrill Lynch, Citigroup, UBS, Bear Stearns and Morgan Stanley, among others, had kept buying.

“If you look at their profitability through a period of intense credit and mortgage market turmoil,” said Guy Moszkowski, an analyst at Merrill Lynch who covers the investment banks, “you’d have to give them an A-plus.”

This contrast in performance has been hard for competitors to swallow. The bank that seems to have a hand in so many deals and products and regions made more money in the boom and, at least so far, has managed to keep making money through the bust.

In turn, Goldman’s stock has significantly outperformed its peers. At the end of last week it was up about 13 percent for the year, compared with a drop of almost 14 percent for the XBD, the broker-dealer index that includes the leading Wall Street banks. Merrill Lynch, Bear Stearns and Citigroup are down almost 40 percent this year.

Goldman’s secret sauce, say executives, analysts and historians, is high-octane business acumen, tempered with paranoia and institutionally encouraged — though not always observed — humility.

“There is no mystery, or secret handshake,” said Stephen Friedman, a former co-chairman and now a Goldman director. “We did a lot of work to build a culture here in the 1980s, and now people are playing on the balls of their feet. We just have a damn good talent pool.”

That pool has allowed Goldman to extend its reach across Wall Street and beyond.

Last week, John A. Thain, a former Goldman co-president, accepted the top position at Merrill Lynch, while a fellow Goldman alumnus, Duncan L. Niederauer, took Mr. Thain’s job running the New York Stock Exchange. Another fellow veteran trader, Daniel Och, took his $30 billion hedge fund public.

Meanwhile, two Goldman managing directors helped bring Alex Rodriguez back to the Yankees, a deal that could enhance the value of Goldman’s 40 percent stake in the YES cable network — which it is trying to sell — while also pleasing Yankee fans. The symmetry was perfect: like the Yankees, Goldman, more than any other bank on Wall Street, is both hated and revered.

Robert E. Rubin, a former Goldman head, is the new chairman of Citigroup. In Washington, another former chief, Henry M. Paulson Jr., is the Treasury secretary, having been recruited by Joshua B. Bolten, the White House chief of staff and yet another former Goldman executive.

The heads of the Canadian and Italian central banks are Goldman alumni. The World Bank president, Robert B. Zoellick, is another. Jon S. Corzine, once a co-chairman, is the governor of New Jersey. And in academia, Robert S. Kaplan, a former vice chairman, has just been picked as the interim head of Harvard University’s $35 billion endowment.

Since going public in 1999, Goldman has been the No. 1 mergers and acquisitions adviser, globally and in the United States, with two exceptions: in 2005 it came in second in the United States rankings, and in 2000 it lost the top spot globally. In both instances, Morgan Stanley took the lead, according to Dealogic.

Goldman, of course, has made its share of mistakes. It took among the most serious write-downs in the third quarter on loans that were made to private equity firms, totaling $1.5 billion. The firm runs one of the largest hedge fund operations in the world, but its flagship funds — funds whose investors include marquee Goldman clients and employees — have had two years of abysmal performance. Clients are expected to redeem billions of dollars of capital at the end 2007.

But Goldman’s absence from the mortgage debacle and the strong performance of its other businesses made up for the write-down associated with the loans. The firm reported $2.85 billion in profit in the third quarter, up 79 percent. Mr. Moszkowski estimates that investment and commercial banks in the United States have taken $50 billion in write-downs related to mortgages, with more coming; Mr. Blankfein said at a conference last week that he expected to take none.

Goldman’s business is built on taking risks, both for itself and its clients. In recent years, Goldman has established the largest private equity and real estate fund complexes in the world. That has led to natural tensions with private equity clients who sometimes complain, but never publicly, about Goldman’s common insistence to team up with them for a piece of the deal.

“Goldman has done the best job of any firm in the U.S. or world competing with their clients but doing business with them,” said one client who asked not to be named because he does business with the firm. “They’ve managed to get their clients to live with it.”

Still, this bottom-line approach has turned off some Goldman veterans and clients. They see the firm’s desire to advise, finance and invest — a so-called triple play — as antithetical to Goldman’s stated No. 1 business principle of putting clients first.

And there is little question that its success in trading, investment banking and servicing hedge funds — many of the traders come right from Goldman — allows the firm a bird’s-eye view on trends and capital flows in the market.

Numerous Goldman investment bankers, former and current, voice the view that Mr. Blankfein’s approach — using Goldman’s investment banking business to develop principal investment opportunities for the firm — creates a brand intended to feed Goldman’s profits rather than relationships. But this harking back to the firm’s golden days as a pure advisory firm does not find much sympathy at Goldman these days.

“I have little patience for these people who talk of the last days of Camelot,” Mr. Friedman said. “Principal investing has been an important and useful business. If you want to be relevant you have to anticipate where the world is going.”

Mr. Blankfein, at the conference last week, echoed that sentiment. “While the integration of our investment banking operations with our merchant bank was somewhat controversial at the time, we felt these businesses were mutually reinforcing,” he said.

Money soothes a lot of concerns, of course, and Goldman has had plenty to spread around. Through the third quarter, Goldman’s $16.9 billion compensation pool — the money it sets aside to pay its employees — was significantly bigger than the entire $11.4 billion market capitalization of Bear Stearns.

Goldman executives and analysts assign much of their success to smart people and a relatively flat hierarchy that encourages executives to challenge one another. As a result, good ideas can get to the top.

But the differentiator that has become clearest recently is the firm’s ability to manage its risks, a tricky task for any bank. Checks and balances must be in place to turn off a business spigot even as it is still making a lot of money for a lot of people. In a world where power gravitates to the rainmakers, that means only management can empower the party crashers.

At Goldman, the controller’s office — the group responsible for valuing the firm’s huge positions — has 1,100 people, including 20 Ph.D.’s. If there is a dispute, the controller is always deemed right unless the trading desk can make a convincing case for an alternate valuation. The bank says risk managers swap jobs with traders and bankers over a career and can be paid the same multimillion-dollar salaries as investment bankers.

“The risk controllers are taken very seriously,” Mr. Moszkowski said. “They have a level of authority and power that is, on balance, equivalent to the people running the cash registers. It’s not as clear that that happens everywhere.”

For all its success on Wall Street, it is Goldman’s global reach and political heft that inspire a mix of envy and admiration. In the race for president, Goldman Sachs executives are the top contributors to Barack Obama and Mitt Romney, and the second highest contributor to Hillary Rodham Clinton. Mr. Blankfein has held a fund-raiser for Mrs. Clinton in his apartment and has come out publicly in her favor.

Another member of Goldman’s influential diaspora is Philip D. Murphy, a retired executive who is the chief fund-raiser for the Democratic National Committee.

All of which has made Goldman a favorite of conspiracy theorists, columnists and bloggers who see the firm as a Wall Street version of the Trilateral Commission.

One particular obsession is President Bush’s working group on the markets, an informal committee led by Mr. Paulson that includes Ben S. Bernanke, the chairman of the Federal Reserve; Christopher Cox, the chairman of the Securities and Exchange Commission; and Walter Lukken, the acting chairman of the Commodity Futures Trading Commission.

The group meets about once a quarter — privately, with no minutes taken — to ensure that government agencies are briefed on market conditions and issues. The group is currently examining the extent to which the packaging and distribution of mortgage loans contributed to the crisis. It also recently completed a study recommending that hedge funds not be subject to further regulation; the group’s fund committee was led by Eric Mindich, a former Goldman trader who now runs a successful hedge fund.

There is no evidence that the conduct of the group is anything but above board. But to some, the group’s existence adds more color to the view that Goldman is indeed everywhere — much as J. P. Morgan was in the early years of the 20th century.

“Goldman Sachs has as much influence now that the old J. P. Morgan had between 1895 and 1930,” said Charles R. Geisst, a Wall Street historian at Manhattan College. “But, like Morgan, they could be victimized by their own success.”

Mr. Blankfein of Goldman seems aware of all this. When asked at a conference how he hoped to take advantage of his competitors’ weakened position, he said Goldman was focused on making fewer mistakes. But he wryly observed that the firm would surely take it on the chin at some point, too.

“Everybody,” he said, “gets their turn.”

Whose language?

By Michael Skapinker

Published: November 9 2007 02:00 | Last updated: November 9 2007 02:00

Chung Dong-young, a former television anchorman and candidate to be president of South Korea, may be behind in the opinion polls but one of his campaign commitments is eye-catching. If elected, he promises a vast increase in English teaching so that young Koreans do not have to go abroad to learn the language. The country needed to "solve the problem of families separated for English learning", the Korea Times reported him saying.

In China, Yu Minhong has turned New Oriental, the company he founded, into the country's biggest provider of private education, with more than 1m students over the past financial year, the overwhelming majority learning English. In Chile, the government has said it wants its population to be bilingual in English and Spanish within a generation.

No one is certain how many people are learning English. Ten years ago, the British Council thought it was around 1bn. A report, English Next , published by the council last year, forecast that the number of English learners would probably peak at around 2bn in 10-15 years.

How many people already speak English? David Crystal, one of the world's leading experts on the language and author of more than 100 books on the subject, estimates that 1.5bn people - around one-quarter of the world's population - can communicate reasonably well in English.

Latin was once the shared language over a vast area, but that was only in Europe and North Africa. Never in recorded history has a language been as widely spoken as English is today. The reason millions are learning it is simple: it is the language of international business and therefore the key to prosperity. It is not just that Microsoft, Google and Vodafone conduct their business in English; it is the language in which Chinese speak to Brazilians and Germans to Indonesians.

David Graddol, the author of English Next , says it is tempting to view the story of English as a triumph for its native speakers in North America, the British Isles and Australasia - but that would be a mistake. Global English has entered a more complex phase, changing in ways that the older English-speaking countries cannot control and might not like.

Commentators on global English ask three principal questions. First, is English likely to be challenged by other fastgrowing languages such as Mandarin, Spanish or Arabic? Second, as English spreads and is influenced by local languages, could it fragment, as Latin did into Italian and French - or might it survive but spawn new languages, as German did with Dutch and Swedish? Third, if English does retain a standard character that allows it to continue being understood everywhere, will the standard be that of the old English-speaking world or something new and different?

Mr Graddol says the idea of English being supplanted as the world language is not fanciful. About 50 years ago, English had more native speakers than any language except Mandarin. Today both Spanish and Hindi-Urdu have as many native speakers as English does. By the middle of this century, English could fall into fifth place behind Arabic in the numbers who speak it as a first language.

Some believe English will survive because it has a natural advantage: it is easy to learn. Apart from a pesky "s" at the end of the present tense third person singular ("she runs"), verbs remain unchanged no matter who you are talking about. (I run, you run, they run; we ran, he ran, they ran.) Definite and indefinite articles are unaffected by gender (the actor, the actress; a bull, a cow.) There is no need to remember whether a table is masculine or feminine.

There is, however, plenty that is difficult about English. Try explaining its phrasal verbs - the difference, for example, between "I stood up to him" and "I stood him up". Mr Crystal dismisses the idea that English has become the world's language because it is easy. In an essay published last year, he said Latin's grammatical complexity did not hamper its spread. "A language becomes a world language for extrinsic reasons only, and these all relate to the power of the people who speak it," he wrote. The British empire carried English to all those countries on which the sun never set; American economic and cultural clout en-sured English's dominance after the British empire had faded.

So could China's rise see Mandarin becoming the world's language? It may happen. "Thinking back a thousand years, who would have predicted the demise of Latin?" Mr Crystal asks. But at the moment there is little sign of it, he says. The Chinese are rushing to learn English.

Mr Graddol agrees that we are unlikely to see English challenged in our lifetime. Once a lingua franca is established, it takes a long time to shift. Latin may be disappearing but it remained the language of science for generations and was used by the Roman Catholic church well into the 20th century.

As for English fragmenting, Mr Graddol argues it has already happened. "There are many Englishes that you and I wouldn't understand," he says. World Englishes , a recent book by Andy Kirkpatrick, professor at the Hong Kong Institute of Education, gives some examples. An Indian teenager's journal contains this entry: "Two rival groups are out to have fun . . . you know generally indulge in dhamal [a type of dance] and pass time. So, what do they do? Pick on a bechaara bakra [poor goat] who has entered college." Prof Kirkpatrick also provides this sample of Nigerian pidgin English: "Monkey de work, baboon dey chop" (Monkeys work, baboons eat).

It is unlikely, however, that this fragmentation will lead to the disappearance of English as a language understood around the world. It is common for speakers of English to switch from one or other variantto a use of language more appropriate for work, school or international communication. Mr Crystal says modern communication through television, film and the internet means the world is likely to hold on to an English that is widely understood.

The issue is: whose English will it be? Non-native speakers now outnumber native English-speakers by three to one. As hundreds of millions more learn the language, that imbalance will grow. Mr Graddol says the majority of encounters in English today take place between non-native speakers. Indeed, he adds, many business meetings held in English appear to run more smoothly when there are no native English-speakers present.

Native speakers are often poor at ensuring that they are understood in international discussions. They tend to think they need to avoid longer words, when comprehension problems are more often caused by their use of colloquial and metaphorical English.

Barbara Seidlhofer, professor of English and applied linguistics at the University of Vienna, says relief at the absence of native speakers is common. "When we talk to people (often professionals) about international communication, this observation is made very often indeed. We haven't conducted a systematic study of this yet, so what I say is anecdotal for the moment, but there seems to be very widespread agreement about it," she says. She quotes an Austrian banker as saying: "I always find it easier to do business [in English] with partners from Greece or Russia or Denmark. But when the Irish call, it gets complicated and taxing."

On another occasion, at an international student conference in Amsterdam, conducted in English, the lone British representative was asked to be "less English" so that the others could understand her.

Prof Seidlhofer is also founding director of the Vienna-Oxford International Corpus of English (Voice), which is recording and transcribing spoken English interactions between speakers of the language around the world. She says her team has noticed that non-native speakers are varying standard English grammar in several ways. Even the most competent sometimes leave the "s" off the third person singular. It is also common for non-native speakers to use "which" for humans and "who" for non- humans ("things who" and "people which").

Prof Seidlhofer adds that many nonnative speakers leave out definite and indefinite articles where they are required in standard English or put them in where standard English does not use them. Examples are "they have a respect for all" or "he is very good person". Nouns that are not plural in native-speaker English are used as plurals by non-native speakers ("informations", "knowledges", "advices"). Other variations include "make a discussion", "discuss about something" or "phone to somebody".

Many native English speakers will have a ready riposte: these are not variations, they are mistakes. "Knowledges" and "phone to somebody" are plain wrong. Many non-native speakers who teach English around the world would agree. But language changes, and so do notions of grammatical correctness. Mr Crystal points out that plurals such as "informations" were once regarded as correct and were used by Samuel Johnson.

Those who insist on standard English grammar remain in a powerful position. Scientists and academics who want their work published in international journals have to adhere to the grammatical rules followed by the native English-speaking elites.

But spoken English is another matter. Why should non-native speakers bother with what native speakers regard as correct? Their main aim, after all, is to be understood by one another. As Mr Graddol says, in most cases there is no native speaker present.

Prof Seidlhofer says that the English spoken by non-native speakers "is a natural language, and natural languages are difficult to control by 'legislation'.

"I think rather than a new international standard, what we are looking at is the emergence of a new 'international attitude', the recognition and awareness that in many international contexts interlocutors do not need to speak like native speakers, to compare themselves to them and thus always end up 'less good' - a new international assertiveness, so to speak."

When native speakers work in an international organisation, some report their language changing. Mr Crystal has written: "On several occasions, I have encountered English-as-a-first-language politicians, diplomats and civil servants working in Brussels commenting on how they have felt their own English being pulled in the direction of these foreignlanguage patterns . . . These people are not 'talking down' to their colleagues or consciously adopting simpler expressions, for the English of their interlocutors may be as fluent as their own. It is a natural process of accommodation, which in due course could lead to new standardised forms."

Perhaps written English will eventually make these accommodations too. Today, having an article published in the Harvard Business Review or the British Medical Journal represents a substantial professional accomplishment for a business academic from China or a medical researcher from Thailand. But it is possible to imagine a time when a pan-Asian journal, for example, becomes equally, or more, prestigious and imposes its own "Globish" grammatical standards on writers - its editors changing "the patient feels" to "the patient feel".

Native English speakers may wince but are an ever-shrinking minority.

Singapore's graduates leap into work

As the job market becomes more competitive, MBA graduates need to "sell themselves," to clinch top jobs globally.

Michael Melcher, a New York partner with Next Step partners, who has conducted training workshops with a number of Ivy League universities, says focusing on soft skills can add value to a student's appeal.

"I've worked in a lot of top schools in the US and Europe, and most of the MBA students need a fair bit of work. Most of them have made huge investments, time and money to get a MBA degree. But most do not know how to market themselves," adds Mr Melcher.

"So we need to work on their soft skills, to help them tell their story to the employers in a convincing manner. At the end it doesn't matter whether you come from Asia or the US, you need to transcend your local levels, and be able to have a global impact."

This is especially true to the MBA students coming out of Singapore, who are a blend of local and foreign graduates. Even though the buoyant economy coupled with a tight labour market has brought about good employment opportunities, the universities admit it is important for their business schools to find quick job placements for their graduates. As a result a lot of resources are channeled into preparing students to be market-ready.

"MBA is an investment. The opportunity costs are high especially for full-time students who quit their jobs. They are looking for a return on investment (ROI), a career progression or a career switch. Thus, through the career services we equip them with soft skills to assist them," says Ms Tan from the NTU business school.

Ms Tay from NUS agrees: "It is who you are and not what school you come from that matters. What we do at the careers services is create an environment where we can prepare our students to be ready for the market. Whether the economic times are good or bad, every company wants the best candidate for the job. We give the students the grounding to articulate their abilities when they meet an employer."

Housewives and contract workers have little savings

CHANGES to the Central Provident Fund will help CPF members retire with more money - but what about those with little or no CPF savings?

Several MPs raised the plight of this group when debating impending changes to the CPF.

For example, housewives, the self-employed, contract workers and odd-job labourers have little or no CPF funds. These groups need extra help from the Government in their old age, said MPs.

Dr Lim Wee Kiak (Sembawang GRC) said some in this group would not be able to afford longevity insurance, which the Government intends to implement.

The plan is for CPF members to set aside a small sum to buy an annuity plan that pays a modest amount when they reach 85, when their CPF savings are likely to have run out.

Dr Lim suggested the Government help co-fund the premiums of people with little or no CPF savings.

Older odd-job workers who did not make regular CPF contributions are another group to be concerned about, said Mr Inderjit Singh (Ang Mo Kio GRC).

Labour MP Halimah Yacob (Jurong GRC) suggested the Government top up housewives' CPF accounts so they can pay for the scheme. 'There are many without the Minimum Sum and women, as we know, live longer than men,' she said. However, she added, she hoped women would not be charged higher premiums.

Dr Ahmad Magad (Pasir Ris-Punggol GRC) suggested giving bonuses to mothers who work part time, so they can top up their CPF.

S'pore will have world's 4th oldest population by 2050

BY 2050, the population in Singapore could be fourth oldest in the world - after Macau, Japan and Korea.

But Singapore is also one of the very few countries tackling the issues of retirement and an ageing population head-on, said Manpower Minister Ng Eng Hen yesterday.

Singapore is greying, and the signs are showing.

He recounted that it is no longer a novelty to meet residents who are in their 80s and 90s during his constituency visits. Foreigners from younger Asean countries are also quick to note the ageing population.

A recent United Nations study confirmed these impressions. It projected the median age of Singapore's population to be 54 years by 2050, behind Macau (56), Japan (55) and South Korea (55).

Said Dr Ng: 'Singaporeans must come to terms with our longevity, both individually and as a nation. And the quicker we do this, the better.'

This means tackling the ageing problem the same way as other national issues - by thinking long term and acting quickly before a problem becomes unmanageable.

The goal, Dr Ng said, is to put in place a better and sustainable Central Provident Fund system that will help Singaporeans save enough for their full lifespan.

But not all Singaporeans recognise they are living longer. Some even think the higher life expectancy has to do with the elderly being 'farm folk' who were born overseas, and not Singaporeans born here, said Dr Ng.

A fact they have to consider is this: There will be fewer working people to shoulder the burden of supporting the elderly.

In 1960, 23 people aged 15 to 64 supported one person aged 65 and above. Now, it is eight people - and by 2030, it will be four people.

While many countries realise they are ill prepared to deal with a population that is ageing, 'not all have been able to act to avoid the impending crisis'.

Some have debated the issue for a long time. Reform commissions such as in France, Ireland and the United States have spelt out what needs to be done.

But in the case of the Irish, its commission failed to agree on a conclusion; China admits it needs to move faster; and pension reform in Italy has been a major stumbling block for successive governments even after 20 years of deliberations.

Then, there are countries that want to postpone the solution to the next generation. Britain, for instance, intends to move its state pension age to 68 - but only by 2046.

Singapore cannot afford to wait so long, Dr Ng said.

'We should not pass these problems of an ageing population to the next generation... Far better to make adjustments now, while we are able and have time on our side. If we wait and are ill prepared, then the consequences for Singaporeans when they are old and dependent will be more painful.'

How higher interest rates will benefit members

Manpower Minister Ng Eng Hen yesterday sketched out details of the CPF reforms and other measures to help Singaporeans build up their retirement savings.His ministerial statement, focuses on three pillars of retirement support - working longer, increasing CPF returns and making savings last as long as one?s life span

IN 20 years, a Central Provident Fund member with $60,000 in his CPF savings will get $17,900 more.

Manpower Minister Ng Eng Hen cited this example yesterday to show just how much a member will benefit from higher CPF interest rates.

Indeed, seven in 10 of all CPF members and more than half of active CPF members will benefit fully from the higher rate, Dr Ng told Parliament yesterday.

From next January, the Government will pay out an additional percentage point on the first $60,000 on all CPF accounts, up to a cap of $20,000 in the Ordinary Account.

This change was announced by Prime Minister Lee Hsien Loong in his National Day Rally speech last month.

It is aimed at helping Singaporeans, especially low-income workers, build a bigger retirement nest egg.

Yesterday, Dr Ng fleshed out details of the CPF changes, revealing that the higher interest rate will cost the Government at least $700 million a year, equal to its annual grant to the HDB.

At the same time, the Government will float the interest rates of the Special, Medisave and Retirement Accounts (SMRA) and peg them to 10-year Singapore Government Securities (SGS) rates.

Under the current system, the SMRA rate is a guaranteed 4 per cent.

Under the new system, the SMRA rate is pegged to the previous year's 10-year SGS rate plus one percentage point.

The average SGS rate is now 3 per cent. Based on this peg, it means the SMRA interest rate will be 4 per cent - the SGS rate of 3 per cent plus 1 percentage point.

To help members adjust to the floating rate, the Government will still pay out a minimum of 4 per cent on the SMRA for the next two years, said Dr Ng.

This 4 per cent floor will also apply to the first $60,000 in the combined CPF accounts that enjoy a higher interest rate.

Since the 10-year SGS was launched in 1998, the highest daily rate it rose to was 5.69 per cent, while the lowest it hit was 1.79 per cent.

Dr Ng said the decision to peg rates to the 10-year SGS was based on several factors.

Among other considerations, the move had to be financially sound, easily understood and not exposed to fluctuations in currency exchange rates, he said.

The ideal peg, added Dr Ng, would have been a 30-year SGS because that would be the average time members' money stayed in their SMRA.

But there was no such bond and shorter bonds of 20 years were not actively traded, making them unsuitable as a peg.

Said Dr Ng: 'Why plus 1 per cent? Because this will adequately provide for the difference we would expect between the interest on the 10-year SGS, which we are using, and the 30-year SGS, if it existed.'

Addressing worries over fluctuating returns, Dr Ng said the new rates should be viewed from a long-term perspective.

'For members' information, had the new SMRA formula been in place since the first issue of the 10-year SGS in 1998, the SMRA rate would have averaged 4.5 per cent,' he noted.

Likewise, he dismissed fears that the CPF changes will deprive fund managers of investable CPF funds.

Under the new rules, from next April, a CPF member will not be allowed to invest the first $20,000 of his CPF Ordinary and Special accounts savings under the CPF Investment Scheme (CPFIS).

Said Dr Ng: 'Money already invested in CPFIS will not be affected. Even after these restrictions, $42 billion will still be available for use in CPFIS.'

A CPF member will still be able to use Ordinary Account funds for housing, CPF insurance and education schemes, said Dr Ng.

There will also be no change to the HDB concessionary loan rate, which is currently at 2.6 per cent, pegged 0.1 percentage point above the CPF interest rate.

Financial analysts like Mr Leong Sze Hian said the change will make people less negative about the floating SMRA rates.

'With the additional 1 percentage point in the formula, there is a good chance that the rates might exceed 4 per cent over the long term,' said Mr Leong, who is president of the Society of Financial Service Professionals.

Accountant Joe Lim, 28, agreed, saying the new formula struck a balance between risk and reward.

Said Mr Lim: 'There is a potential for slightly higher gains while the extra 1 percentage point acts as a buffer for my savings. Not too bad a deal.'

Singapore’s CPF Retirement Scheme: Delivering More Bang for the Buck

Singapore’s CPF Retirement Scheme: Delivering More Bang for the Buck
From Knowledge@SMU

Singapore’s Central Provident Fund (CPF) is one of Asia’s oldest and best known defined contribution retirement schemes. Established in 1955 as a mandatory savings programme, theCPF now has over 3 million members with balances representing about 15% of Singaporeans’ total wealth. As the country rapidly ages, second only to Japan in terms of low fertility rates and longest life expectancy, government policymakers are paying close attention to whether its citizens and residents are saving enough for retirement.

Singapore Management University finance professor Benedict Koh, and Wharton insurance and risk management professor Olivia Mitchell recently prepared two working papers on Singapore’sCPF Investment Scheme (CPFIS) in which they examine the asset allocation of CPF investors and the cost of investing in unit trusts.

How the CPF Works

CPF member contributions go to three accounts where they earn government-set interest rates: the Ordinary Account (OA), earning 2.5% interest, which could be used to purchase homes and insurance, and support education and other expenses; the Special Account (SA) intended mainly for retirement savings; and the Medisave account for medical and critical illness insurance. Both the SA and Medisave earn 4% interest each, if the funds are invested on members’ behalf by the government. At age 62, SA savings are transferred to a retirement account which can also earn 4% interest and pays an annuity over 20 years up to age 82. Contribution rates to theCPF depend on age and income, and range from 8.5% to 33%, up to an income ceiling of S$4,500 per month. All contributions and withdrawals are tax-free.

The CPF has evolved over 50 years from a “forced savings scheme” to a “wide-ranging social security system”. At the end of 2005, account balances totalled nearly S$120 billion, about three-quarters the size of Singapore’s GDP that year. 49% of members’CPF balances were in the OA, 17% in the SA, 29% in Medisave, with the balance 5% in retirement and other accounts. Since 2003, CPF assets have grown at an average rate of 7%.

“Asset Rich Cash Poor Phenomenon”

According to Koh, Mitchell, Tanuwidjaja, and Fong (“Investment Patterns in Singapore’s Central Provident Fund”), the bulk of cumulativeCPF contributions (44%) have gone to the purchase of residential and investment properties. A sizeable portion (29%) remains in the OA and SA accounts, earning guaranteed interest, while only 10% of the funds were invested in capital market instruments permitted under the CPFIS .

The authors note that the heavy investment in a single property can lead to “an asset rich, cash poor phenomenon” in Singapore. They suggest that policymakers consider restricting the proportion of saving used to purchase property to helpCPF members ensure they have sufficient funds for retirement. Other policy options might include spurring the growth of a reverse mortgage market, and allowing homeowners to freely rent out their apartments for income. Recently, the government has changed rental rules for public housing estates where around 80% of Singaporeans live. Homeowners may now rent out their flats after owning them for 3 years, while those who have taken government funds to purchase their homes can rent after 5 years. The authors feel that such actions by the government may be prudent, so as to enable cash-strapped retirees to transform a consumption good (their residence) into an investment good (rental property) to generate cash for daily expenditures.

Asset Allocation

The authors note that CPF saving “clearly represents a sizeable portion of household’s total wealth…Therefore it is important that CPF holders be proactive in maximising investment returns on CPF saving”. Today, CPF account holders are allowed to invest a portion of their OA and SA funds in a wide range of capital market instruments including fixed deposits, bonds, property funds, equities, annuities, endowment policies, unit trusts, investment-linked insurance policies (ILPs), exchange traded funds and gold. Currently, there are 400 different unit trusts and ILPs on offer. However, the authors’ research shows that “the bulk ofCPF saving today is still held in the government-managed default fund”. As of December 2006, only 10% of funds have been invested while another S$79 billion is retained in the OA and SA accounts.

One reason for the low investment rate, the authors suggest, is that people may prefer to keep their money in the relative safety of aCPF default investment account. Another explanation they offer is that “participants may simply not know what to invest in and how to invest. Being perplexed, members may choose the path of least resistance, which is to simply leave their funds with theCPF and earn the guaranteed return.” Such inertia may be justified by the finding that three-quarters of CPF members in 2006 who enrolled in the CPFIS’s offerings had made losses or earned less return than the 2.5% payable on their CPF ordinary accounts .

Of the funds that were invested (S$27.9 billion), 67% went into insurance policies such as annuities, endowment policies and ILPs, 20% in equity and loan stocks, while only 12% was in unit trusts , collective insurance schemes offered by fund management companies.

The authors also find that men tend to be slightly more proactive in managing their CPF investments as compared to women. Men tend to invest more of their saving in shares, while women tend to put more into insurance products. Contrary to the advice of financial planners,CPF investors tend to take more risk as they age. The more mature (56+) age group commits a higher proportion of saving to stock investments and less to insurance products, compared to younger age-groups. The asset allocation ofCPF investors also differs across income groups. Those in the lower income groups tend to hold less risky investments as compared to the higher income groups.

“Hidden Costs”

In a second paper, “Cost Structures of Investment Offerings in Singapore’s Central Provident Fund”, Koh, Mitchell, and Fong suggest that another possible reason for the low rate of investment ofCPF funds is the “daunting array of fees and charges, minimum initial investments, and other fund features, making it difficult for the unsophisticated investor to know what to elect”. The two largest fund costs are the initial sales charge and the expense ratio. The sales charge ranges from 0% to 6% but has typically been 5%. To address this issue, as of 1^st July 2007, the CPF Board capped initial sales charges at 3%.

The expense ratio ranges from 0% to 7% of the fund’s net asset value. It is important since this is a yearly cost, whereas the sales charge is a one-time cost. The study found that the average expense ratio was 2.1% for actively managed funds allowed under the CPFIS and 1.0% for passively managed funds. There are 164 actively managed equity funds included in the CPFIS and only 3 passively managed ones. Balanced funds (bonds and equity) also had an overall expense ratio of 1.9% while income funds (bonds) showed an average expense ratio of 1.1%.

A third cost becoming more widespread is a “wrap fee” which is charged by financial advisers and insurance companies. It can be as much as 1.5% and is not part of the expense ratio. The authors point out that “unwary or uneducated investors may not be fully appraised of these additional charges.” A fourthcharge is transaction fees and agent bank fees. Bank transaction fees are charged under the OA but not the SA scheme. There is a quarterly service charge of S$2 to S$5 collected by the agent bank for servicing eachCPF investment account. There is also a S$2 to S$2.50 transaction fee per lot of shares purchased unless one works with an Investment Administrator to consolidate purchases. As of the end of 2006, there were threeCPF-approved Investment Administrators.

A fifth charge is hidden expenses, also not included in the expense ratio. This refers to brokerage commissions and the impact of the bid-ask spread on costs. It also includes taxes deducted at source and foreign exchange conversion costs. Although not a cost, investors are also subject to foreign exchange fluctuations. This may be thought of as a hidden risk since it is not easily seen by investors. Marketing and advertising expenses are also excluded from the expense ratio as are interest expenses. ILPs (but not unit trusts) generally include an insurance charge; some ILPs also include a service fee of up to 0.75%. Neither is part of the expense ratio. Less common hidden expenses are a realisation charge (back-end load), redemption fee (for selling in a short time such as 90 days) and switching fees (for switching within a family of funds).

The authors argue that passively-managed funds (regardless of fund type) could be less expensive to manage than actively-managed funds, due to the lower turnover of securities and less monitoring required Passive equity funds have average sales loads that are more than 50% below the sample mean. The same cost difference holds for balanced funds.

The authors also carried out a regression analysis to explain observed cost patterns. They find that (i) ownership, (ii) style of fund management and (iii) type of fund are key factors. Foreign-owned funds are found to charge 42 basis points more in sales load than locally-owned funds, 16 basis points more for management fees, and 53 basis points more in first-year total costs. Actively managed unit trusts charge more than passively managed funds. Equity and balanced funds charge more than income and money market funds. Larger funds are also found to be slightly less expensive than small funds, charging 8 basis points less. According to the authors, “passive funds are often deemed suitable for novice investors who are not sufficiently confident to select their own stocks or unit trust; they may also be suitable for long-term investors seeking growth but who lack the time to actively manage their investments.”

The authors also recommend streamlining and rationalising the many investment choices to include inflation-protected instruments, more index-linked funds, and low-cost life cycle funds. The latter especially are a cost-effective way to diversify and rebalance investments to suit the investor’s life stage. They cite the Chilean experience where investors are defaulted into higher risk funds when younger and automatically transit to more conservative portfolios as they get older, unless they opt for a different investment mix. Other ideas for encouraging investments to enhance investor returns are to aggregate and simplify data on fees and charges, and to provide education and learning aids, such as on-line calculators, that would help investors compare offerings and take decisions on how to optimise their savings for retirement.

“The CPF has taken several measures recently to moderate retail costs for investors. These include setting more stringent criteria for admitting new unit trusts into the CPFIS, continually reviewing existing unit trusts, capping sales charges, and developing investor education programmes that advise its members to make informed decisions,” says Mitchell. “In the longer term, theCPF could continue to fine-tune costs, devise default funds with acceptable risks and returns, and even harness market forces to drive down costs and enhance net returns.”

Published: August 2, 2007