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Pensions pondered in Thailand

Category: Thailand, Global
By Toby Garrod

Experts say rotation to equities may be muted

Institutional pensions and investments were the topics of the day at Asia Asset Management’s Fifth Annual Thailand Roundtable in Bangkok on November 20, 2012. The conclave gave leading players from Thailand’s financial establishment a chance to exchange views on both local and global issues.

A broad consensus was soon evident on the need for domestic institutional funds to work on home bias issues while taking advantage of the chance to diversify and improve bottom line results through international exposure; but participants were at odds as to the direction of global interest rates.

Domestically, Thailand’s pension reform programme prompted discussion around the pace of change.

On pension reform and investment internationalisation, the president of Thailand’s Provident Fund Association, Pisit Leeahtam, emphasises the need for rapid modernisation of Thailand’s pension fund industry.

“Thailand is like many other countries around the world in that we are ageing very quickly as a society. In the next 30 years our working population will be in decline with many more people retiring. Expectations are that the ratio will fall to about 2.5/1, taking us close to levels in Europe, Japan and the US. So there’s an urgent need to study retirement savings realities.

“Unfortunately, our authorities have not prioritised this as yet. The government pension fund was started around 15 years ago when the government had a lot of money. That was before the Asian Financial Crisis. Nevertheless, government employees enjoy a very robust pension scheme.

“Help for those in the private sector, however, has come late compared to other countries in the region, such as Hong Kong, Singapore and Malaysia. It was inaugurated under the so-called social security system less than ten years ago.”

Mr. Pisit further notes that Thailand also has a provident fund scheme on offer, which according to the World Bank is a third-tier voluntary private pension scheme. It is not compulsory. Anyone that wants to save can pay into a fund, with concomitant contributions from employers. But he acknowledges that this programme has been subject to many limitations over the years.

The number of people paying into the scheme currently stands at around 2.5 million, as against a total workforce estimated at about 35 million people. So only a little more than 5% of the working population has a savings scheme in place for their old age.

“Even though there are about ten million workers that can get support through the Social Security Fund (SSF), the amount provided under this scheme is very small. It simply provides a subsistence level annuity,” he adds.

Aside from the lack of participants and cash in the pension system, the profiles of the pension funds are also a major cause for concern:

“Most of the money now accumulating in these funds is earmarked for investment into debt-related products, such as government bonds, bank deposits and debentures. Only about 13% is invested in equities, or in other forms of investment, a very small slice compared to international pension industry norms. Traditionally, people have not really trusted the stock market, seeing it as a place where people gamble. Those attitudes are changing now, however.”

Another discussion focussed on boosting investment returns on government-controlled funds.

Panel moderator and chairman of Thailand’s Financial Planners Association, Teera Phutrakul, asks Win Phromphaet, head of global and real estate investment at the Social Security Office what could be done to improve asset-liability management in the SSF.

Adjusting the balance

“While the fund has been earning returns of about 7.4% since inception – quite decent for a big fund of this type – it won’t go on forever: the investment profile is too conservative given our liabilities. We’ve done a study which shows that if we keep our current profile of 90% fixed income, 10% equity, returns will devolve to about 4.5% going forward,” he says. “If, on the other hand, we allocate more monies to global equity markets and less into global fixed income, plus more to global corporate and emerging market bonds, and a lot more to real assets, including real estate and commodities, in short re-balancing allocations between low risk and high risk from 90:10 to 60:40, we should be able to boost our overall return to about 5.5%.

“Obviously this will involve investing a lot more outside of Thailand and into riskier assets. Which in turn means that we will start seeing one year in ten, or 15 years, delivering negative returns. Nevertheless, this short-term risk will improve the overall long-term risk profile.”

Mr. Win is not alone in this view.

“I share his concerns as to whether the pension system will have enough to provide for the future elderly,” says Somjin Sompaisarn, CEO and chairman of TMB Asset Management. “It is something of a rule of thumb with international pension funds that 60% of their portfolios tend to be higher risk or growth assets. Raising Thai pension fund risk level parameters will be challenging, however, as the decisions made regarding asset allocation in the retirement funds are normally taken in committees which focus more on annual volatility and risk protection than the long term goals of the retirement fund.

Moderator Mr. Teera shifts the discussion to the home bias issue, asking how this might impact Thailand’s pension dilemma.

“We [the SSF] are getting too big for the Thai market. If we were to sell our government bonds today the market would crash. If we were to sell our Thai equities the market would also crash,” says Mr. Win.

Additionally, not only the size but also the variety of investment opportunities is an issue. For instance, he notes that in Thailand there are really only two major sectors, financials and energy. Lacking others of significant size, such as pharmaceuticals or food and beverage, there are limited choices of investment targets. And that’s driving Thai investors to look offshore.

“In fact, Thai pension investors have placed almost half of their money outside the country as of now. And that is just the beginning of it.”

The ASEAN angle

With the emergence of the ASEAN Economic Community (AEC) poised to play a critical role in decisions regarding overseas investment, Mohit Mehrotra, partner at Deloitte Consulting Southeast Asia, financial services industry, strategy and operations, updates the audience on the implications for Thailand’s financial services industry of the regional economic integration set to take effect in December 2015.

“The AEC is divided into four pillars,” he explains. “The first is the single market and production base, likely to be the one we understand the best and hear the most about. According to ASEAN, as of March 2012, Thailand had progressed 65.9% of the way toward achieving its goals for this segment.

“The second is the competitive economic region, which covers policy on competition, consumer protection, intellectual property rights and infrastructure development. Here the assessment is that the country has moved forward in all of these areas, achieving a 67.9% rating. The third pillar, equitable economic development, likewise shows solid progress at 66.7%.

“Yet the final pillar, integrating into the global economy, is the one where the greatest progress is evident, resulting in an 85.7% rating. And we know there have been several free trade agreements signed, such as the ASEAN-China and ASEAN-Korea free trade agreements (FTAs). So by December 2012, the assessment was that the overall scheme is 72% along the way to achieving the AEC’s goals by year end 2015.”

The middle-income trap

Unfortunately, Thailand is finding itself vulnerable in relation to regional integration.

“Thailand’s status and competitiveness vis-a-vis these goals has been sliding in all key areas, such as rule of law, education, and productivity,” Mr. Mehrotra states. “This translates into losing attractiveness to other countries.”

For instance, as regards education and development, Thailand finds itself somewhat mired in the middle-income trap, which is when a country’s growth plateaus before stagnating at middle income levels, a result of being squeezed between the manufacturing power of low-cost developing countries and high-value developed-market peers. While there have actually been ups and downs in inbound investments, foreign direct investment (FDI) data reveals an overall decline since 2006. Thailand ranks fourth in the region in terms of FDI. Vietnam, Myanmar and Indonesia hold the top three places.

Quest for yield

Shifting focus to the international high yield markets, Philippe Descheemaeker, AXA Investment Management’s Paris-based head of product specialists and fixed income, discusses opportunities in the debt space against the backdrop of a low-yield environment.

“With so much asset allocation toward fixed income, a prime challenge for investors is the need to find more yield within fixed income to compensate for the lack of allocation toward equities or alternative investments. This makes yield enhancement the name of the game for most investors I am meeting these days, and it seems to be a converging theme in almost every region of the world. The result has been the emergence of heightened demand for spread products, investment grade credit, high-yield, and emerging markets.”

This trend is unsurprising given the options.

“When talking about yield or yield enhancement, we think the absolute minimum for investors should be to find an investment that at least offsets the erosion occasioned by inflation,” Mr. Descheemaeker believes. “When we look at the government bonds arena right now, we note that few of these investments compensate for current inflation projections.”

Though asset reallocation has proven extremely useful in terms of increasing returns, new perspectives on traditional investment tools are also needed to take full advantage of the current environment.

“For many institutional investors, their confidence in the traditional indices that they have used has been slipping for a number of months now,” he says. “For instance, they see problems in using market weighted indices in which those companies with the biggest weightings are also those that have the greatest levels of debt, and so are probably the most fragile.

“As regards yield, we are paying close attention to break-even analysis these days. This means that we are trying to understand various sub-asset classes in fixed income to see if we would invest in them for a full year based on information we have today, taking into account the kinds of protection and potential returns that the asset classes might offer up to the point where returns go into negative territory. For instance, US T-notes today offer a potential return of less than 2%, which is extremely low. Meanwhile, the protection offered by the yield widening that could sustain over a one-year period is only 20 basis points; clearly not enough. No protection at all, in fact. In Europe, even the most conservative of investors I have been meeting in the past 18 months have all started to build asset allocations in high yield.”

There’s a surprisingly solid case for high-yield debt in the world’s biggest market.

Says Mr. Descheemaeker: “One of the main opportunities is the US high-yield space, where we have seen US$10 billion in inflows – a record for us. While such inflows could be interpreted as a sign of weakness, in this instance it is actually a sign of strength. That’s because most of the increase in issuance is linked to refinancing. So as yields are going lower and lower, companies are actually refinancing and pushing the maturities further out. This relatively small amount of outstanding debt and lack of short maturities is very encouraging to us. It means that the risks of default linked to financing are very low.

“Another key point is that leverage has gone down since the 2009 peak. We are now at a level that has never been reached before, so that from a fundamental standpoint and a demand standpoint the situation appears to be very strong.”

Another view on fixed-income is put forward by Eugene Morrison, institutional portfolio manager at Fidelity Investments, who offers a take on US investment-grade credit markets. Fidelity employs over 200 fixed-income professionals and manages over $850 billion in fixed income, including both bond and money market assets.

“It’s becoming clear that fixed income is going to become an increasingly important part of our organisation. It already comprises about 50% of our AUM,” says Mr. Morrison.

Such a shift flies in the face of what he calls “common misconceptions” regarding the bond markets.

“First, there is a belief that the US market is a bond bubble waiting to burst. Many investors say that if bond yields rise again, as they did between 1940 and 1970/80, investors are going to lose all their money. Another misconception is that because bonds yields are so low, people should take their money out of fixed income and put them into dividend paying equities.”

Mr. Morrison believes US investment grade credit is potentially a solution to some of these issues.

“Central banks are clearly keeping policy rates low; this is evidenced by both policy rates on the front end and extraordinary measures like the quantitative easing programmes, as well as other items like Operation Twist, in which the Fed is moving from shorter-dated securities out to longer-dated securities to keep rates down.”

But he says there are reasons why rates may not move as quickly as some people expect.

“The first is the global debt overhang and deleveraging. Whether you are talking about governments, consumers or banking institutions, there’s a tremendous amount of debt on balance sheets that needs to be removed. By nature, that is deflationary.

“Another thing is low growth. All around the world, from the UK and Canada to China, growth has fallen by around half in the past five years, and this has enormous implications for the emerging markets; many, if not most, of whom are net exporters. Current moderate inflation is also significant. We expect inflation may move up over time, but we don’t expect it to be dramatic. If you look at inflation across the world right now we are at 2% or 1% in many places – both the UK and Japan are at 0%. There are, of course, those places which do have it, such as India, Argentina and Venezuela.

“That aside, changing demographics will prove critical over the medium to long term as ageing populations drive a need for more safety and income oriented solutions,” he says. “These solutions have traditionally been fixed income. That’s why we believe the demand for fixed income is going to continue. At the same time there is a trend toward pension de-risking, especially in the US, where all corporate pension plans are taking down their equity allocations and going into fixed income. Mainly to long duration fixed income, and particularly long credit because that is the best hedge against their liabilities, which are discounted using long high-quality corporate bonds. So demand there is not going to go away.”

The combination of these factors means that the direction and severity of interest rate changes may be markedly muted.

 “If we look at the ten-year treasury yield in the US going back to 1920, we can see that from 1923 to 1963 rates were between 2-4%. If you read the work of Carmen M. Reinhart and Kenneth Rogoff, in the book ‘This time It’s Different’ [2011], you’ll see that coming out of financial crises, and the debt overhangs that they cause results in a low-growth environment, sometimes for 20-plus years, Mr. Morrison observes.

“It’s not our base case that yields are going to go lower, as they did in Japan. But the point is that they can go lower. If I was standing here three or four years ago, we would have had the same discussion.”

Rotation to equity

Still, with the fixed income markets set to either remain low or rise, it’s not surprising that investors are increasingly focussing on the somewhat oversold equity markets.

Sanjay Natarajan, institutional equity portfolio manager at MFS, discusses the outlook for the global economy and its implications for equity markets.

“MFS is predominantly an equity manager of over $300 billion, of which about 75% is in equities,” he says. “The key focus of our investment approach is bottom up and fundamental quality focus approach, which has really helped us over the past four-to-five years.

Mr. Natarajan reckons investors will need to dramatically alter the way that they manage equities in the coming years.

“A lot of alpha has been generated by equity managers, or by clients in terms of asset allocation – such as a focus on Chinese or emerging market equities. I don’t think that is sustainable,” he contends. “A lot of this has been based on fiscal or monetary stimulus, or some exogenous factor that is driving market performance in the short term. I personally believe economic fundamentals matter.”

“Another point is that if we’re in a low growth environment and we’re trying to seek returns through market timing, we should note that stock-specific risk and correlations are exceedingly low. This tells you that investors are very scared and not really very discerning as to what is a good quality business versus its poor quality counterpart. Everything is trading at or near a market multiple.”

Despite the broader market fears there have been pockets of gains, however.

Mr. Natarajan goes on to say: “Markets clearly rallied in Q3, especially in the US and Europe. This came on the back of policy action by the Fed, the European Central Bank, and China’s central bank. In fact, over the past 12 months we’ve had about 258 policy actions worldwide. But the impacts of these actions don’t last. Meanwhile, risk continues to run very high as global growth is still sputtering, with ongoing structural problems bubbling up. And it’s not just in the developed world that we have issues: they’re also ongoing in emerging markets because the business model there has to change fundamentally in response to the low growth environment.

“Finally, since the Lehman Crisis, alpha generation has really come from beta allocation. Correlations are just too high. But I am confident that this will change moving forward. As we move from a stimulus-driven market to a more fundamentals-driven market, I think the best way to generate alpha is to own the right kinds of businesses. Our point is, don’t simply track the index. Find the right companies to own across the world and use them as a hedge against market volatility.”

The final panel discussion of the day discussed opportunities and limitations linked to the alternative investment strategies deployed by Thailand’s institutional fund managers.

Moderator Thanathip Vidhayasirinum, co-founder and managing director of Sage Capital, asks Yingyong Nilasena, deputy secretary general of the Fund Management Group at Thailand’s Government Pension Fund, what it means to invest in alternative investments in the Kingdom.

“Here alternative means non-conventional, excluding equity and bonds, typically covering relatively safe products like real estate and property, but also including higher risk exposures such as commodities, private equity and hedge funds,” he replies.

“Typically, there are a lot of property funds open to Thai investors; and commodities funds and futures are widely available. But in more rarefied areas such as private equity, these funds are only available to selective types of institutional investors. And as for hedge funds, I think there are only a few Thai investors that are allowed to invest given internal rules.”

Aung Htun, executive chairman of Thai Strategic Capital Management, elaborates: “There are a number of players in the alternatives space in Thailand. But they tend to come from ultra-high net worth families, he says. “The products are usually sold to them by private bankers, commonly foreign private bankers, or the very largest institutional investors, but I don’t see many local insurance companies investing in this space.”

Interestingly, Mr. Yingyong goes on to explain that there are technically few limitations. But most private equity funds domiciled in Thailand need to be registered, given the current regulations, which require that they use a public fund structure, which includes diversification rules among other key restrictions.

Commenting further on private equity matters, Mr. Aung notes that there are a number of equity mutual funds that from time to time buy pre-IPO stock. But this, in fact, is borderline PE practice as they are committed to be listed within a year. “There are usually a very small amount of these and they are not usually offered in a fund structure. Rather they are bought directly from a broker,” he says.

“From a general partner’s point of view, raising capital from the domestic market can be very tricky. All of our funds are structured offshore, typically the Cayman Islands. We know how to manage our own tax affairs well, therefore we don’t really want to explain to a domestic institution how to get their money offshore and into our fund. It’s too much work, frankly. Most insurance companies have very tight rules on what they can and cannot invest in. So for that reason alone, they could only do a very small portion in private equity. If they were to do Thailand-based private equity, they would probably feel they were better off buying Thai stocks, because they haven’t got country diversification; and they will have lengthened the maturity of their portfolio by taking on unlisted assets, plus the additional risk of illiquidity. As a result, we don’t see the need to talk to domestic institutions, by and large, at this stage.”