Pension funds in the region are seeking more diversity in investments and demanding higher levels of services from their managers, and, as so often is the case, Asia is leapfrogging the evolutionary stages that have been established in more developed markets.

Although Asian corporate and government pension funds generally remain much smaller than funds in Europe or the US, they are growing in size and importance. One of the biggest changes has been their eagerness to invest outside their home markets. 

Many South Asian pension funds have only recently begun investing overseas, while North Asian funds have been investing overseas for some time but are now becoming more sophisticated.  They have expanded their investments from traditional asset classes in Europe and North America to alternative investments such as private equity, hedge funds and long/short funds.

Laurence Bailey, chief executive officer of J.P. Morgan Worldwide Securities Services in Asia, estimates that the percentage of assets being invested across borders averages about five percent in much of Asia, compared to 40 percent in Australia and 10 to 15 percent in Japan.

“Just like kids these days are growing up used to touch screens, pension funds going overseas for the first time today are adapting to what is available now,” Bailey says. “There is no legacy.”

Moving in sync

While Asia’s pension funds vary greatly in their level of sophistication, they are all moving in the same direction. While smaller funds are very consultant driven, the bigger ones have more expertise and analysis in-house. That means that most just what they want and need when they come knocking on a fund manager’s door.

The growth of sovereign wealth funds (SWFs) across Asia has helped develop the pension industry as well. There are many similarities between the needs and obligations of national pension funds and SWFs, and therefore pension funds have been looking to SWFs for inspiration.

Stewart Aldcroft, senior advisor for Securities and Fund Services within Citi’s Global Transaction Services, remembers how pension funds were run in Hong Kong in 1980s. They would choose their managers purely based on the last quarter’s performance, and were therefore constantly changing managers and being disappointed by the results. He believes the higher sophistication of SWFs has pushed pension funds to up their game.

“There still is a long way to go, but there is so much similarity between SWFs and pension funds that it has allowed them to learn from each other.”

Broadening their horizons

Investing pension fund money overseas has been one of the most pronounced changes across the pension industry in recent years, and the trend continues as they look to serve their members better with diversified investments that deliver solid results.

Nick Wright, head of services and markets for South Asia at State Street, noted regulations are being relaxed on where pension funds can invest, opening doors to emerging markets such as Latin America, Eastern Europe, Africa and the BRIC countries, as well as the CIVETS – Colombia, Indonesia, Vietnam, Egypt, Turkey and South Africa. “The key questions for a pension fund that is going outside its borders for the first time are very much around the risk reward issue.”

“How does the market operate, and ask questions not just about the underlying investment, but also at sovereign risk, currency risk. What is the real return and what is the risk?”

Pension funds are also broadening their horizons from their traditional reliance on fixed income, cash and money markets, and this trend will only accelerate over time as fixed income returns are predicted to remain low. They are also putting more money into alternative investments such as private equity, venture capital and real estate.

However, Aldcroft says Asian pension funds are still slow to realize the benefits of alternative investments, with the five percent or less of assets committed to the asset class on average.  There has been a growth in use and offerings of alternative asset classes, but not much increase in use of hedge funds. “There is a focus on enhanced risk budgeting and dynamic risk management, including placing an overall risk overlay portfolio strategy over the current tactic allocations strategy.”

“There is growth in products providing international diversification strategies and ETFs as new instruments to pension funds.

Outside expertise

An increased appetite for overseas markets and more adventurous investments has created the need for more expertise, and pension funds are going outside their own offices to find it, outsourcing more of their asset management.

Some pension funds bring in an asset consultant to advise them where and what to invest in and get the process started, while other funds plunge straight into emerging market investing. However, there can be challenges with their custodians and infrastructure if this is the first time they have done cross-border investing. Bailey says it is important that the funds have an idea of what they need and want before they choose their manager.

“The fund manager has a critical job on investment decisions, but the pension funds need to decide what platform they want to use and what they expect to get from the manager,” Bailey says. “Once they decide that they want to invest offshore, from an asset servicing perspective, we want to do it quickly, broadly and deeply. If the fund doesn’t get the foundation in place first you have the same problem you’d have when you’re building a house.”

“That way the manager can play by the rules of the road rather than back into an existing system.”

Bigger funds are doing the simple, on-shore management themselves, getting a manager to do the more complicated stuff. Bailey says: “We see them as very different and earlier adopters of the new ways of doing business. That means they’re not willing to pay a manager to run an index fund, they want to pay for alpha. They’ll do the index funds as cheaply and easily as possible.”

He notes that some Australian pensions are now bringing management back in-house after having outsourced it because they have become more sophisticated managers themselves - due to the education offered by external managers. While he expects that to become a trend in Asia, the cross-border investments will likely remain in external managers’ hands.

Nick Hoar, the head of Asia Pacific for Neuberger Berman, says while some pensions are still going to external managers for the first time, he also sees a lot of mandate replacement, triggered by volatile markets, poor performance and the general shake-up of the financial services industry in the last few years.

“If we do win a piece of business that was with another manager we find they are far more specific around the guidelines that they want us to manage their money against, and also the level of client service,” Hoar says. “They’re more precise.”

Special has become standard

As pension funds learn from SWFs and their increased interaction with fund managers they have begun asking for much more than they once did. Drastic technological changes have also changed what kinds of sweeteners a manager can offer in order to win a mandate.

Given the ugly portfolio secrets that were revealed by the global financial crisis, it is no surprise that pension funds are more stringent when it comes to transparency. State Street’s Wright says: “They are very keen to understand exactly what is going on why the manager is investing in certain places. They want to understand the risk, the alpha, and what general, counter party or country risk they are being exposed to.”

This has meant a sharp increase in the monitoring demands. While five years ago pension funds were content with monthly or quarterly reports, which were issued 10 days after the effective date, today they are asking for daily or even intra-day transparency. 

“They are very keen to understand exactly what is going on why the manager is investing in certain places. They want to understand the risk, the alpha, and what general, counter party or country risk they are being exposed to,” Wright adds.

“We’re seeing a drive, on both the service and asset management sides, to look at more local requirements in Asia - things such as Islamic finance and Sharia compliance,” Wright says. “If you look around the region we’re in, you have countries such as Indonesia with its huge Muslim population, and they have a natural interest in these things.

Aldcroft agrees that pension funds are looking for enhanced performance attribution and forecasting capabilities, in particular, around the fixed income markets, and pointed to Citi’s Yield Book as an example.

Pension fund are also using more than one global custodian in order to gain the best practices, competitive pricing services and diversification of counter party risk. However, when investing in more and unfamiliar stock markets, using a single custodian for all can be a major reduction in administration. Aldcroft says: “Pension funds are increasingly demanding insight into the pension fund industry from the service providers, including insight on best practices on investment process and peer fund intelligence.”

He adds fund managers have begun to offer pension funds new features in order to leverage cross-border investment channels and new asset classes and increase transparency around foreign exchange - features such as auto FX products and passive FX hedging solution to manage FX risks and on line money market funds access, to gain FX advantage, higher yields and instant access. They also offer third party administration and analytics services for the alternative investments including private equity, fund of hedge funds and real estate as well as portfolio accounting reporting complying with international accounting standard.

Some of the offerings to pension funds not yet in the standard offering category include middle office outsourcing, collateral management services to manage the counter party risk for the OTC derivatives and stock lending, as well as cash, collection and payment services to improve operation efficiencies.

Asian pension funds are also no longer content to deal with a manager based in New York or London. They want someone on the ground whose face they recognize.

“A few years ago, a lot of the big global names in pension fund management did not have operations in Australia, so they would fly in and out to make their pitch and win a mandate, commit to return to do quarterly or biannual investment reviews, and pension funds were comfortable with that,” Bailey says. “Now, as funds get bigger, they value on the ground service and touch points.”

This has prompted many fund managers to open multiple new offices across the region. “The pension funds are saying, if you want to manager our money or be our administrator, we want to see you, you probably need a local person and someone we can trust,” Bailey adds.

“We used to hub everything in Hong Kong, Sydney and Tokyo. Now managers have expanded to Taiwan, Singapore, Seoul and Mumbai.”

The Asian pension fund industry may be small compared to that of Europe and North America, but it has come leaps and bounds in its best practices over the past five years. With fund managers offering more services and education in their eagerness to gain mandates in emerging markets that trend of sophistication is sure to continue.