New perspectives

Category: Asia, China
By Hui Ching-hoo

AAM roundtable finds pension reform is topping the agenda across the region

Many Asian governments have put pension reform at the top of their agendas in a bid to tackle the issue of their ageing populations.

To gain some insight into the dilemma, Asia Asset Management, in conjunction with Changjiang Pension Insurance Co Ltd and MFS Investment Management, held its ninth annual China roundtable in Beijing on April 15, bringing together experts from regulatory bodies, pension funds and pension product providers. They candidly shared their views of pension investment trends amid ongoing market uncertainties.

Managing expectations

Bingwen Zheng, director general of the Centre for International Social Security Studies at the Chinese Academy of Social Sciences, said that he is sceptical over whether a standardised, government-funded social pension system is feasible for China. As he sees the issue, such a directive would be a burden on the country’s financial strength.

“Pension expenses have made up a relatively high proportion of China’s productivity. Our first pension pillar accounted for about 2.6% of GDP in 2012, as against 1.1% in Korea,” he pointed out. Addressing the second and third pillars, Dr. Zheng said that the size of China’s aggregate fundamental pension and enterprise annuity (EA) products amounts to around 1 trillion RMB (US$160 billion) and 600 billion RMB, respectively, which is far from sufficient to address the country’s pent-up demand.

Hideo Kondo, asset management director with Japan’s DIC Pension Fund, said that his fund encompasses two types of defined benefit (DB) schemes – life annuity and fixed-term annuity. “The first two pillars of the Japanese pension system are directed by the Japanese government. DIC is mainly responsible for managing the third pillar. Taken together, however, these pillars complement each other in providing employees with comprehensive retirement protection,” he remarked.

As for matching liabilities, Dr. Zheng argued that it is not practical to apply the US DB model in China, even though the investment cost is much less compared to defined contribution (DC). There are many other factors, such as moral hazards, that the regulator needs to take into account. Also, the lifespan of Chinese enterprises tends to be much shorter than that of their US counterparts. In this situation, the Chinese government would have to assume the burden of liabilities under DB should an enterprise fail.

Xiong Jun, deputy director of the asset allocation and research department at the National Council for Social Security Fund, pointed out that the key difference between DC and DB is in the definition of who is responsible for risks. In China, members demand that their EA product delivers good results under various market circumstances. Because of this, he says, the responsibility of EA trustees is much greater.

CIO perspectives

He Shaofeng, director of the finance and assets department for enterprise annuity management at China National Petroleum Corporation, used the metaphor of a 100-metre sprint to illustrate public perception of the short-term asset allocation and performance expectation of the EA scheme and a marathon to modify the perception of its investment horizon. In other words, EA managers resort to short-term asset allocation to meet current demand.

“This misconception, and the inadequacy of investor education, are the main problems that need to be addressed in promoting the EA scheme,” he said.

Li Chunping, president of Changjiang Pension Insurance Co Ltd, echoed Mr. He’s view, noting that it is impossible to design a one-size-fits-all EA scheme to accommodate the wide array of demands, especially for huge state-owned enterprises. “From the trustee’s perspective, we need to categorise our customers based on their investment needs,” he noted.

Mr. Li said that Mainland EA schemes cannot just follow the US pension model and allocate up to 50% to equities, when the expected and historical returns of the A-share markets generally fall short of the scheme’s assumed return.

Still, he praised the relaxation of the investment scope of EA products. This new initiative allows EA funds to invest in alternative assets. This can help to strengthen portfolio stability, he highlighted.

However, Wayne Bi, deputy general manager at ICBC Credit Suisse Asset Management, argued that loosening these restrictions might entail new risks. Investors, therefore, must be more aware of the liquidity risks of trust products when rebalancing their portfolios.

“Our firm will increase its weighting in stable-return assets moving forward. From an asset manager’s standpoint, we’ll be striving to strike a balance between various elements such as long-term and short-term objectives, and absolute return so as to maximise our overall return under different market conditions,” Mr. Bi said.

According to Kevin Chen, chief investment officer, pan-Asia, of AXA Rosenberg, foreign pension funds have greater flexibility in dealing with downside risks. Despite the fact that risk tolerances for Mainland pension products are very diverse, Chinese pension products have been making progress in terms of dealing with unfavourable market conditions since the global financial crisis.

Low-yield regimes

Addressing the impact of QE tapering, Jonathan Tiu, chief executive officer of MFS International Singapore Pte Ltd, said that the monetary pullback was relatively moderate against previous yield cycles, and that market participants have become accustomed to the ascending yield of US treasuries: “In the fixed-income space, we observe that the current yield spread remains very low. That is unlikely to compensate for the fallout from interest rates that will ultimately rise,” he predicted.

In terms of real estate investment, William Leung, senior vice president and portfolio manager at Cohen & Steers Asia Ltd, said that real estate investment trusts (REITs) delivered above par performance (14%) over the previous eight rising interest rate cycles occurring between 1993 and 2013.

“We’ve seen that US real estate did very well this year, with growth averaging 10%. So our clients are switching their monies out of safe assets,” he said. “We’re trying to create more value for our clients by diversifying more of our investment into cyclical real estate asset classes. We favour office properties in Hong Kong and Japan which are expected to be the beneficiaries of the global economic recovery.”

Mr. Tiu added that the record net inflow of $600 billion into equities funds last year could only bode well for this market’s outlook.

“We’ve also seen strong demand for high-dividend equities from the institutional side. For example, Taiwan’s Labor Pension Fund appointed MFS as one of the three external managers for its global high-dividend-yield equity mandate late last year. Our take on investment is to not only focus on dividends paid but also on the companies’ prospects for capital gain. We’ve constructed a portfolio with dividend payout of about 3.8%, which is close to the MSCI high-dividend index yield.”

Zeng Liyu, research and design director at S&P Dow Jones Indices, anticipated that investors would not execute any significant shift of their asset allocations in response to the easing of the US monetary measure. Rather, she sees investor appetite for long maturity fixed-income products dwindling further in the long run. “In the ETF universe, there are a variety of income generation tools. For example, dividend ETFs garnered a lot of attention last year, as evidenced by their net capital inflow topping $27 billion in 2013,” she pointed out.

She went on to say that REITs, and US and Canadian preferred stock-linked ETFs are the other ideal alternatives for yield-seeking investors. “With the diversity of the alternative investment tools available, investors should not only focus on a single asset class but rather deploy multi-asset strategies in building a more diversified portfolio.”

Next generation

Sun Hao, managing director, head of institutions, Greater China, AllianceBernstein, explained that there has been a prolonged debate on the pros and cons of the centralised or delegated pension model in China: “The centralised model is relatively cost-effective and efficient. However, in working with the delegated model, local authorities have more flexibility in designing the investment scope, contribution proportion, and risk tolerance based on local economic conditions.”

Kai Sotorp, head of Asia-Pacific at UBS Global Asset Management, added that standardisation is critical: “If the authorities want to promote portability, whether under the common system or segregated system, it should have exactly the same set-up for integrating operations. However, it is pretty difficult to apply a unified common system in China because of the size of its population.”

James Xu, general manager of Ashmore Investment Management China, observed that enhancing investment returns has become an increasingly important theme for pension funds worldwide, especially with so many pensions now hit by historical deficiencies and near-empty accounts.

Mr. Xu saw RMB appreciation as running out of steam on the back of the People’s Bank of China relaxing bilateral exchange rate volatility, which had resulted in domestic investors raising their overseas exposure. “Citing Japan as an example, Japanese investors significantly shifted their capital overseas in the 1980s. And the stellar performance that was enjoyed as a result ended up offsetting the pitfall of yen depreciation.”

He added that the pension market is closely related to the development of financial infrastructure, such as the stability of the local debt market. “We’ve seen the Chinese government recently outlining some financial reforms that will help improve the industry environment,” he commented.

Comparing the Mainland pension system with the US model, Keith Yuen, regional vice president and principal, International Asia Ltd, stated that the US 401(K) pension system has been a key factor underlying the growth of the US capital market.

“Pension capital flows have turned out to be a virtuous cycle through which a significant amount of retirement monies have been channelled into US equities and debt markets. In fact, long-term pension monies own about 40% of the New York Stock Exchange market cap,” he said, adding: “I think China is going through a transformation stage in which the Chinese government wants to channel more pension monies from bank deposits to more productive long-term funding. That, in turn, will be beneficial to the country’s pension industry and economic growth.”

Ma Li, chairman of Changjiang Pension Insurance Co Ltd, remarked that liberalisation, diversification, and market allocation will play a key important role for the pension market going forward, noting investment diversification will help to improve pension’s investment return to hedge against devaluation risk. She also highlighted the importance of establishing a centralised supervisory system for the fund and said a liberalised management system should also be introduced to regularise market competition.

Texas perspective

R David Kelly, chairman of the Teacher Retirement System of Texas (TRST) board of trustees, contended that the DB-structured pension scheme is very efficient in terms of providing its members economies of scale, sophistication of investment and proper distribution. The TRST is one of the largest US pension plans, with total AUM of around $126 billion.

“The fund’s second leg is our healthcare system, which supplements the US national Medicare plan. The third leg is the self-directed investment programme, which is complementary to our DB system. Our plan is fairly unique in the sense that 95% of the benefit payments to our members come exclusively from our pension plan, while their healthcare payments derive from a combination of the government fund and the fund provided by our pension trusts,” he explained.

Despite retirement models in many countries having gradually shifted from DB-structured to DC-structured, Mr. Kelly argued that the latter has a number of drawbacks. Topping the list is that its members run the risk of not having enough money in their accounts at retirement. This means that the government has no choice but to step in to make up the deficit.

He went on to say that, “In comparison, we believe the DB system is the cheapest way to deliver a specific standard of living with its economies of scale. Taking our pension plan as an example, we effectively control the DB system process to get the most efficient benefit outcome.”

Mr. Kelly continued: “Despite the DC scheme with its greater membership mobility, the government needs to take responsibility for the outstanding liabilities of some US DC schemes. Members’ contributions are simply not sufficient to cover their retirement.”

Of course the DB system has disadvantages as well, such as a lack of discipline, Mr. Kelly remarked, adding that this is why many politicians renege on their promises to replenish retirement funding.

He stated that TRST has a return assumption of 8.5%, which means that the fund is allowed to invest in various alternative assets such as derivatives, hedge funds, private equity and real estate.

Furthermore, the pension has strong risk tolerance. It invested $4.5 billion in alternative assets, even though its portfolio depreciated by 40% during the financial crisis. These investments ultimately managed to deliver an average return of 25% for six consecutive years.