CHAPTER 5
CONSTITUTION OF THE PRIVATE RETIREMENT SCHEMES
Learning objectives
This chapter explores the constitution of the PRS.
At the end of this chapter, you should be able to:
(a) list the different types of funds within the Scheme;
(b) explain the concept of trust and what an advantage it is to have a Scheme Trustee to care for the interest of the members;
(c) explain what the trust deed and supplementary deeds are;
(d) explain how the investment objectives of the fund govern the type of funds offered to members;
(d) identify the risk level of the core funds and other common types of funds;
(e) explain the similarities and differences between the PRS and unit trusts; and
(f) recognise the differences between the PRS and unit trusts as well as other retirement products such as annuities to contrast with voluntary additional contribution to the EPF.

5.1 Type of funds within the Scheme
The purpose of the PRS is to facilitate asset accumulation by members for use in retirement. Thus, a range of funds must be available within the Scheme to cater to the particular demands of the PRS member. The PRS Guidelines allow the PRS Provider to offer a range of seven conventional funds. This limit may increase up to a range of 10 funds if the PRS Provider plans to offer Shariah-compliant funds under the Scheme. Alternatively, a specific Scheme may be established for Shariah-compliant funds only.

Default options are for members who select their PRS Providers but do not specify a fund option. Another case may be where the employer channels contributions to a particular PRS Provider but where employees do not make a fund selection, these contributions will be allocated to the default option of that PRS Provider. The objectives of having the default option of core funds in every PRS are to ensure that for members who do not choose specific funds, their contributions are channelled into a fund that is appropriate given their age.
At all times, the PRS Provider must ensure that the Scheme which it offers to the public has the default options consisting of core funds. The three core funds are—
(i) the conservative fund;
(ii) the moderate fund; and
(iii) the growth fund.

5.2 Instruments constituting the Scheme
(a) Concept of trust
A PRS under the CMSA framework is a retirement scheme governed by a trust.
In common law legal systems, a trust is a relationship whereby property is held by one party for the benefit of another. With regard to the PRS, the Scheme Trustee holds the assets (fund assets like cash, stocks and bonds) on behalf of the member and these assets are held separately from the PRS Provider’s assets and segregated by each fund under the PRS and clearly identified as the fund’s property.
The composition of these fund assets may change during the course of the year (e.g. from the initial subscription cash to equities and back to cash again for distribution), but the assets always remain under the control of the Scheme Trustee. In the event the PRS Provider encounters financial difficulties and has solvency issues, the members’ PRS assets will still be safe as they are segregated from the PRS Provider’s assets.

(b) Advantages of the trust arrangement
The Scheme Trustee has a fiduciary duty and a legal responsibility to act impartially in the best interest of the members. Even though the PRS Provider, through the fund manager, has day-to-day operational authority (e.g. they can act on behalf of the fund by buying and selling shares, bonds and other property), the assets and monies reside with the Scheme Trustee. The Scheme Trustee holds assets for the member in trust and segregates them from the assets of the PRS Provider. These assets would be safe even if the PRS Provider experiences illiquidity or undergoes insolvency proceedings as the segregation prevent them from being claimed by any creditors of the PRS Provider.
(c) The deed
Since the PRS is governed by a trust structure, the PRS Regulations impose a requirement for a deed to be registered with the SC to ensure that a trust governing the establishment and operation of the PRS is created and entered into between the PRS Provider and the Scheme Trustee. In this regard, the provisions and covenants of the deed must meet the minimum requirement specified in the PRS Guidelines.
The covenants of the deed will include the duties and responsibilities of the various parties involved (including the PRS Provider and Scheme Trustee), as well as the full particulars of the PRS and funds within the Scheme. The deed must be registered and lodged with the SC. Any modification of the deed can only be done through a supplementary deed which is also required to be registered with the SC.
(i) Covenants of the PRS Provider and the Scheme Trustee
The covenants of the PRS Providers and the Scheme Trustee, the joint
covenants of the PRS Providers and Scheme Trustee, as well as other
covenants can be found in Schedule C of the PRS Guidelines.
5.3 Authorisation of the funds
The funds under the PRS can consist of core funds and non-core funds which must be authorised by the SC. An application for approval of a Scheme must include the application for authorisation of at least the core funds under the Scheme, whereas for non-core funds, application may be made at any time after the approval of the Scheme containing the core funds.
The authorisation of a fund may be revoked if—
(a) any information or document furnished in the application is false or misleading or contains a material omission;
(b) the core funds are not launched within six months of the authorisation;
(c) the PRS Provider failed to comply with the directions of the SC or the requirements of the PRS Guidelines; or
(d) it is to protect the interest of the public or the members as a whole.

5.4 Naming of the funds
(a) Core funds (default funds) The core funds in a PRS are default funds which must be named:
(i) (Insert Name of the PRS Provider) — Growth Fund;
(ii) (Insert Name of the PRS Provider) — Moderate Fund; and
(iii) (Insert Name of the PRS Provider) — Conservative Fund

b) Non-core funds under the PRS
For non-core funds, the PRS Provider and the Scheme Trustee must ensure that the name given to a fund or class of units must be appropriate, not misleading or conflicts with the name of another fund. The SC has the right to ask the PRS Provider to change the name of the fund or class of units if it deems the name inappropriate.
5.5 Investment objective of the Scheme
The investment objective of the Scheme and the funds within the PRS must be clearly, specifically and sufficiently stipulated in the deed.
(a) Different funds for different risk tolerance
Although the ultimate purpose of the PRS is to facilitate asset accumulation by members for use in retirement, members of the PRS will have different investment objectives and risk tolerance that must be considered. The PRS Consultant needs to assess these objectives vis-a-vis the risk tolerance and advise the members accordingly on what the volatility of returns are like for the funds in the PRS and the possible risk of substantial capital loss if invested in certain funds. The members must realise that potentially high returns come with higher risk.
Members must also be made to realise that although there is a default option, which is age-based, this may not be suitable for all members as some members of that age may prefer a more conservative or aggressive portfolio. The default options are made based on the age of the member and this default allocation
(b) Non-core funds under the PRS
For non-core funds, the PRS Provider and the Scheme Trustee must ensure that the name given to a fund or class of units must be appropriate, not misleading or conflicts with the name of another fund. The SC has the right to ask the PRS Provider to change the name of the fund or class of units if it deems the name inappropriate.
5.5 Investment objective of the Scheme
The investment objective of the Scheme and the funds within the PRS must be clearly, specifically and sufficiently stipulated in the deed.
(a) Different funds for different risk tolerance
Although the ultimate purpose of the PRS is to facilitate asset accumulation by members for use in retirement, members of the PRS will have different investment objectives and risk tolerance that must be considered. The PRS Consultant needs to assess these objectives vis-a-vis the risk tolerance and advise the members accordingly on what the volatility of returns are like for the funds in the PRS and the possible risk of substantial capital loss if invested in certain funds. The members must realise that potentially high returns come with higher risk.
Members must also be made to realise that although there is a default option, which is age-based, this may not be suitable for all members as some members of that age may prefer a more conservative or aggressive portfolio. The default options are made based on the age of the member and this default allocation follows the investment maxim that if the member’s investment horizon is longer (i.e. the member is younger), then the member can afford to take more risks and more volatility of returns. This may not be true for everyone as some young investors may be risk-averse and would prefer a heavier concentration of bonds and some older investors made be just the opposite. The PRS Consultant should ascertain that the member is comfortable with the risk profile of the core funds before recommending them.
Where a member does not select a particular fund under the PRS, a fund within the default option (core funds) that corresponds to their age would be selected by default. The details are listed below:

(i) Conservative fund
Asset allocation for members aged 50 years and above 80% in
debentures/fixed income instruments of which a minimum of 20% must
be in money market instruments and a maximum of 20% in equities.
Investment outside of Malaysia is not allowed under this option.
(ii) Moderate fund
Asset allocation for members aged 40 to 50 years
A maximum of 60% in equities.
(iii) Growth fund
Asset allocation for members below 40 years of age
A maximum of 70% in equities.

It is important to note that the asset allocation decision imposed on
the member through the restriction in investible instruments as well as
the allowable quantum for the default funds will minimise portfolio risk
to make it appropriate for the member’s age. For example, maximum
allowable limit of 20% in equity investment for the conservative fund
limits the volatility and return risks of the fund and this is appropriate given the member is already preparing for retirement and should not be exposed to much risks.
(b) General risk and return profiles of certain types of fund
(i) Cash management fund
Invested primarily in money market instruments and deposits, the
volatility of returns for this type of fund is relatively low. The returns of this fund should reflect that of a fixed deposit account and is the least risky compared to other types of funds.
(ii) Conservative fund (a core fund)
With a maximum of 20% invested in Malaysian equities and the rest in fixed income instruments (and a minimum in a money market fund), the volatility of returns are quite low although higher than the cash management fund. Returns would also be higher than the cash management fund but generally lower than those with a lot of equities exposure. The high proportion of fixed income instruments mean that this fund is less risky than equity or balanced funds with higher percentage of equity exposure but more risky than the cash management fund.
(iii) Moderate fund (a core fund)
With a maximum of 60% invested in the Malaysian and overseas equity
markets, we can expect the volatility of returns to be quite high and
varied. Returns are expected to be higher than the conservative fund in
the long run because of the higher equities exposure. This is a balanced
fund with a mix of equities and fixed income instruments and will
provide diversification of asset returns over time. The high percentage
of equities component in the fund means that this fund is more risky
than the conservative and cash management fund but less risky than
a pure equities fund or the growth fund which has a higher equities
component.
(iv) Growth fund (a core fund)
With a maximum of 70% invested in the Malaysian and overseas
equities markets, we expect the volatility of returns to be the highest
among the core funds. Returns are expected to be higher in the long
run because of the higher equities component. The growth fund
is less risky than a pure equities fund but more risky than the cash
management, conservative and moderate funds due to its higher
proportion of equities holdings.
(v) Index funds
The aim of this type of funds is to track an index and replicate the
return for its unit holders. The volatility of returns and risk associated with the index funds will be dependent on the type of index it tracks.
Some of the possible index funds and their risk levels:
(a) Country index — Equities emerging markets
(b) Emerging country indices like China’s Shanghai Composite or
India’s Nifty Index are very volatile. This is a very risky fund due
to the 100% equities components. Furthermore, this type fund is made up of emerging market equities which is more risky than developed markets equities.
(c) Country index — Equities developed markets
Developed country indices like the UK and Japan are made up
of more established companies and the returns of the index
would be more stable compared to emerging markets. This
type of fund is less risky than a fund made up of emerging
markets equities but inherently more risky than funds that have
less equities components.
(d) Regional index—Equities
Regional indices provide the investors with more diversification
(companies from different countries) and some specific
investment objectives (e.g. Asia REITs). The returns would
be relatively stable. This type of funds is less risky than the
country index funds as it offers more diversification but it is
still more risky than bond funds because of the 100% equities
component.
(e) Global index — Bonds
A global index will comprise multiple country components and
individual issues. This diversification will result in a stable return
profile for this type of index. Furthermore, the underlying
asset is less risky compared to equities. This type of fund is less
risky than the equities index or country funds but more risky
compared to the cash management fund.
(c) Volatility
Volatility is a measure of the variation of a price of a financial time. The funds mentioned above contain equities, bonds and other assets
which have daily variation in prices and hence the fund itself would have daily variation in NAV. A volatile fund is one where the daily returns fluctuated within a large band of possible prices whereas a less volatile fund means that the daily return would fluctuate within a narrower band of possible prices.
5.6 Modification of the deed
A deed may be modified by another deed (called the supplementary deed) if the supplementary deed is—
(a) registered with the SC;

(b) accompanied by a special resolution passed by members of the PRS
(two-third majority except for the purpose of terminating or winding
up a Scheme or fund where at least 3/4 of the value of the units
held by members voting at the meeting is required) if the modification
materially prejudices the interest of the member (e.g. changes to the
investment objectives, change in the risk profile, change in fees and
charges); and
(c) accompanied by a statement from the Scheme Trustee and PRS Provider stating that such modification does not materially prejudice
the members and prior notice (of at least 21 days written notice) has
been given to the members of the PRS.
5.7 Similarities between unit trusts and the PRS
The unit trusts and the PRS do share some common characteristics. Both provide diversification of assets and have a trustee to look after the interest of the members and unit holders. Both the investments in the PRS and unit trusts are pooled and invested according to the mandate and guidelines of the funds that make up the scheme or unit trust. Both are products to encourage the members and investors to make long-term savings and investment decisions.
So while the underlying products (i.e. funds) are the same for both the PRS and the unit trusts, the PRS has a completely different set of rules and regulations to adhere to.
(a) Comparison between the PRS and other retirement products
(i) Annuities
Annuities are usually purchased from insurance companies and are
contracts whereby the annuitant (the person who buys the annuity)
receives a series of fixed payments at regular intervals (usually monthly)
from the insurers until the death of the annuitant. Each annuity
payment represents the repayment of a portion of the purchase price
plus interest earned. The purchase price may be done at one go (a lump
sum payment) or more likely in the context of saving for retirement,
paid monthly/annually over the working life of a person. The annuity
payment will start once the person retires or has fully paid the purchase price.
Annuities are common drawdown or post-retirement products whereas
the PRS is more geared towards savings accumulation for retirement.
Once a member reaches the retirement age, he may use the PRS funds
to purchase an annuity that would provide him with regular income for
a fixed period or until his death depending on the terms of the annuity.
There is no uncertainty to the return and payout as the annuities are
contractual and pre-determined as it is just a contractual agreement with the insurance company. It is fully funded and the returns are pre-determined. 

One of the drawbacks of the annuity is that the annuitant would have to bear the risk of the insurance companies as they are the ones guaranteeing the returns of the annuity. There is no direct link on market performance to the return of the product and the return will depend on the financial health of the insurer. Another drawback is the surrender of the annuity. If the annuitant cannot make the payments and is forced to surrender the policy, then the annuitant stands to lose a substantial portion of the paid contribution. Commission rates may also be hefty for these products.

(ii) Investment-linked insurance products
An investment-linked insurance product combines elements of
investing and life insurance into a financial product. The premiums
provide not only a life insurance cover but part of the premium will also be invested in specific investment funds of your choice. The insured will be able to choose how to allocate the insurance premiums towards protection and investment.
This is predominantly an insurance product and the cash value of this
product can be derived after deducting the unallocated premiums
which are commissions to agents (maybe up to 160% of the premium payable over at least six years), insurance charges, policy fee and fund management charges. It is apparent that there is hardly any surrender or cash value in this type of product in the first years of the policy until the unallocated premium and other charges are paid up and enough of the premium gets allocated to the investment fund and the investment returns start to build up.
(iii) Private retirement schemes
Core funds
Every PRS has to offer three types of core funds — the conservative
fund, the moderate fund and the growth fund. The unit trust provider
and insurance companies on the other hand can offer any type of
funds to the investing public. The choice offered is often based on the
demand indicated by the public. There are no choices of funds within
an annuity.
Default option
Every PRS has core funds that will be default options for members who
do not make a fund selection. The core funds attempt to place the
member into a category of fund with risks that are commensurate with
the age of the member (i.e. the investment horizon of the member).
Every unit trust holder and buyer of insurance products must specify the
fund that they wish to buy before a transaction can take place. There is
no default option for other retirement products.
Sales of units and withdrawal of monies
The PRS is meant to encourage members to save for the long term and
for their retirement. The contribution into a PRS sub-account A thus
cannot be withdrawn until the member reaches the retirement age.
Only contributions into sub-account B may be withdrawn and even
then, withdrawals may only be made once a year and subject to a tax
penalty.
There is no such restriction for unit trusts. Investors can generally buy
and sell unit trusts freely subject to the specific restrictions of each unit trust. For investment linked insurance products, the cash value in the first years of the policy would be low and it may not be worthwhile for the investor to cancel the policy then.
(b) Advantages of the PRS over other retirement products
(i) PRS investments are portable
The member can easily transfer the accrued benefits from one PRS to
another managed by a different PRS Provider through the PPA. For unit
trusts and investment linked insurance products, the investors may be
subject to high dealing charges again when making the subsequent
purchase. Given the nature of the investment-linked insurance product,
the policy holder may get back far less than what they had paid for
earlier.
(ii) PRS contributions are eligible for income tax relief
Up to RM3,000 per annum of contributions to the PRS are eligible for
tax relief. Annuities also enjoy this tax benefit but monies used to buy
other retirement products like unit trusts are on an after-tax basis.

Question 1
PRS Provider Delta has three core funds in their Private Retirement Scheme. Which of these names can be accepted as names of the core funds?
I. Delta Growth Fund
II. Delta Cash Management Fund
III. Delta Moderate Fund
IV. Delta FBMKLCI Tracker Fund

A. I, II and III only
B. I and III only
C. II and III only
D. II and Iv only
[Answer: B]

Question 2
Arrange these funds from the most volatile returns to the least volatile:
I. Equities Emerging Market Index Tracker fund
II. Conservative fund
III. Moderate fund
IV. Cash Management fund

A. I, II and III
B. I, III, II and IV
C. 1, III, IV and II
D. IV, III, II and I
[Answer: B]

Question 3
What are the similarities between the Private Retirement Schemes and unit trusts?
I. Both encourage long-term investments’
II. Both are governed under a trust structure
III. Both have core funds
IV. Both investments are pooled according to the mandate of the funds

A. I and II only
B. II, III and IV only
C. I, III and IV only
D. I, II and IV only
[Answer: D]