Backdrop to the Pacific century
The launch of Investment & Pensions Asia is a reflection of the increased focus on this region, economically, structurally and as an investment destination. The following are some of the key factors at work in our market.
■ The development of pension systems: Traditional Asian pension systems are either being extended or dismantled in favour of systems that are more
easily funded. As this process evolves, the growth in assets is expected to be huge. Investment of
pension assets will require more sophisticated management.
■ The growth of fund management: Institutions
and private savers are beginning to acknowledge that a diet of domestic bonds is not the best opportunity for them to meet their retirement obligations. Fund investment is already well entrenched in places like Japan, Australia, Taiwan and Hong Kong. The Asia Pacific region will see the fastest growth of assets under management globally in the next five to 10 years.
■ Outsourcing: Western companies continue to relocate towards cheaper Asian sources of labour, while Asian governments and institutions are increasingly tapping the global knowledge bank. Tighter regulation to increase the responsibility of pension fund trustees will see much more of the operational and supervision work being farmed out to specialist firms.
■ Improved macroeconomic stability: Since the Asian crisis, Asian economies have shown a greater resilience. This is expected to result in better government, more stable markets and improving corporate governance. The recent crackdown on corruption in Shanghai and the exposure of false accounting by senior officials in Taiwan can be seen as a sign that the governance systems are working.
Growth of pension assets
Asia is home to 60% of the world’s population
- 3.9bn people, or 10 times the size of the EU.
In the next 10 years, the OECD expects pension assets in Asia to grow by more than 250%, to €3trn under management. In its own in-depth report, Allianz believes Asian pension assets will grow five-fold outside Japan and Australia by 2015.
At present, pension coverage is low and most of Asia’s public pension systems are unfunded. But governments around the region are working to resolve this. There are two main approaches to pensions in Asia. The first is the Central Provident Fund type used in Singapore, Malaysia and to some extent Thailand as well as the Mandatory Provident Fund in Hong Kong. Each of these is essentially a DC approach. They contrast with the various civil service and private employer-based DB schemes in India, Korea, the Philippines and Thailand. For the DB schemes, the coverage of the labour force ranges from very low (India) to 30% (Thailand) to largely universal (Korea). Replacement rates for covered workers range from 30% in Thailand to
50-60% in Korea and the Philippines. Because most of the DB schemes are pay-as-you-go, it is assumed they will prone to the same financial pressures as industrial countries once the elderly dependency rate (EDR) rises.
Harald Conrad of the German Institute for Japanese Studies (DIJ) says “A number of Asian countries have pre-funded mandatory savings schemes that do not enjoy functional autonomy from government and have done a poor job of managing their investments. There is a need for policies and institutional and regulatory frameworks to ensure better investment returns.”
Bob Parker at Credit Suisse says that with Asia Pacific assets under management due to grow to $24trn by 2009, from $17trn currently, “this is the area of the largest growth globally”. A move away from bonds is evident in the forecasts, with the big winners likely to be enhanced index products, ETFs and alternatives, particularly private equity, hedge funds and structured products.
Parker also forecasts that most countries will see the fastest growth in the personal pensions area of investment.
Although they lag two decades or so behind the industrialised countries, the sharp decline in fertility rates and rising longevity in Asia will result in a growing proportion of elderly people in Asia, relative to both the overall population and the number of working age people. Economist Peter Heller, in a report to the IMF’s Finance & Development journal, says, “Asian countries sit astride the ‘demographic transition’. Some, such as Korea, Taiwan and Singapore, are much more advanced in the process, with the EDR converging to industrialised nation levels by 2030 and with further dramatic increases forecast in subsequent years.
By 2010, the population over 65 in Japan will be 22% of the total, compared to 13% in Singapore, 8% in Thailand and around 5% in Malaysia and India. By 2025, it will up around 30% in Japan, but only 12% in Thailand and still less than 10% in Malaysia and India.
At the same time, the supply of labour is going to become relatively scarce. Chart 1 shows that, with retirement age for males at 55 in the case of Indonesia, Malaysia and Thailand, there is a need for labour market and pension policies that encourage higher participation in order to create a more favourable economic dependency ratio.
The DIJ research looks at the impact of capital flows increasing as the pool of developed world retirement savings goes in search of higher returns. The US will continue to have a younger population and will remain a capital import country, while Japan remains a capital exporter. Other Asian countries will probably profit from rising capital imports and increasing FDI, if capital flows are further deregulated and corporate governance can be improved.
Increasing investment allocations to Asia
Despite the recent strong performance of Asian equity markets, the consensus view holds that there is still a great deal of growth potential in the Asian region. There has been a noticeable shift in sentiment by international investors in the last two years. China’s boom is undeniably a major contributor to this. The ongoing liberalisation of Asian markets, the region’s continued and rapid economic expansion and the increasing influence of globalisation have added to the drive.
For the Asian region, projected average economic growth of near 7% is expected to sustain itself throughout most people’s tactical horizon. Meanwhile the developed world is running at about half that pace and is on a declining curve. The US is projected to moderate from 3.4% growth in 2006 to 2.8% in 2007, the Euro-zone from 2.1% to 1.7% and Japan to hover around 2%.
It’s interesting to look at how this growth picture pans out. The US, with a $12.5trn (€6.3trn) economy growing at 3% produces $375bn of growth. Asia, ex Japan, with a $5.7trn economy growing at 6% produces $342bn of growth. Add in Japan’s contribution of $4.8trn growing at 2% ($96bn) and you have Asia leading the charge in the global economy. The OECD is projecting that with this growth differential persisting, by 2015 ‘emerging markets’ as an asset class will constitute 55% of the global economy.
So Asia is rightly seen as a dynamic growth region where real progress has been made. That is being gradually reflected in institutional allocations to the region. Allianz Global Investors chief executive in Asia, Mark Konyn says, “The whole texture of investing in the region has changed. You have a growth story that is sustainable, restructuring is well underway, there is greater stability in the banking sector and we are seeing growth in the local debt markets.”
Also, with two new economic powerhouses emerging, the focus is being deflected from Japan but in a positive way. Konyn says, “In the past you have separated Japan out from the rest of Asia. Now, the story is about the interaction of Japan and China, or Japan and Korea.”
Merrill Lynch’s chief economist in Tokyo, Jesper Koll, suggests investors should not lose sight of Japan in all the talk about China and India being the drivers of growth. “Japan is a reliable engine of growth and remains the world’s largest supplier of capital, the world’s largest creditor country. And that outward investment and lending is going to accelerate.”
Just as importantly, Japan has successfully reduced massive public funding, cross-shareholdings are down sharply and now 80% of Japanese equity responds to normal market mechanisms. The biggest risk to Japan is the ageing population. So while productivity gains are made, wage growth due to a chronic labour shortage could cause major problems.
Risk to markets
Opinions remain strongly divided on whether we have entered a new era of more sustainable growth for Asian economies. No one should suggest there will not be periods of heightened volatility, but one needs to consider whether in the post-crisis environment, Asian markets are really that much more prone than other world markets. Yes, there are still structural issues that need to be worked out. Many of the countries lack transparency and an effective regulatory regime. The Indian equity market is rife with insider trading. We have yet to see the markets tested by another exogenous event like SARS. And while Asia’s markets are expanding, asset inflation is a real risk given the lack of depth amid such robust demand.
Tensions in the system are inevitable and these will bring changes to Asian economies, because of the need to allocate capital more effectively and generate stronger growth. This will only intensify as the ageing population problem kicks in. The weight of money by itself will not be enough to push through all the changes that are necessary in Asia’s markets. But with greater involvement of foreign investors, companies and governments will be encouraged to continue the reform process and to make sure the tap does not get turned off.
Where will we be in the future?
Mere mortals find it hard to think 30 or 50 years into the future. But Jim O’Neill of Goldman Sachs, the man who coined the phrase ‘BRICs’, is confident of his prediction that Brazil, Russia, India and China will be the major growth engines of the next 30 years and that by 2035, the BRICs economies could be bigger than the G7.
In 2006, the largest economies in the world are the US at $13trn, Japan at $6trn, Germany at $3trn and the UK and China at $2trn. In 2050, the top 5 is China ($53trn), the US ($38trn), India ($27trn) Japan and Brazil (both $8trn)
So China and India will both be winners, but O’Neill says the potential of India is greater, given where it is now. He believes India has “fantastic potential” and predicts that by 2050, its economy will be 50 times larger than today, and its people 30 times wealthier.
Although its labour market dynamics are also “fantastic”, with 300m additional workers over the next 20 years, O’Neill says India needs clear, more accountable macro-economic policies, more openness on trade and FDI and a much broader level of quality education.
If India takes its opportunity and if all these countries deliver on their productivity potential, the world will look very different for our children and grandchildren.