Asian Pensions / SWFs - FOFs not attractive

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Asia after the global storm

by Huichen Chou 29 May 2009

Huichen Chou looks at how Asian investors have been impacted by the economic crisis and what they are doing to lessen its impact

The tempestuous storm of global financial turmoil sweeping the world has definitely not left Asia unharmed. Exposure to international and domestic equities has resulted in detriments to Asian institutional investors as a whole, including government pension reserve funds.
According to FTSE World Indices in 2008, the Pacific countries excluding Japan, China and Hong Kong suffered from 50.4% equity losses in dollar terms, while Japan and Hong Kong posted 42.0% and 50.1% equity drop respectively within the same period.
Against the backdrop of bleak equity capital market data, Fidelity International's managing director Asia Chris Ryan states that the region's national pension funds have been relatively less impaired by the global financial crisis compared with their Western counterparts. This is due to their substantial allocations in fixed income and the region's favourable credit environment in the past 18 months.
The Citigroup World Government Bond Indices in 2008 recorded 27.8% gains in dollar terms for the government bond returns in Japan. Meanwhile, Dealogic data illustrated that US Treasuries excluding municipal bonds posted 102% on-year volume gains in 2008. In Asia, the domestic bonds of Japan, South Korea and China priced within the year surged 11%, 38.5% and 123% in volume compared to 2007.
To shore up recessive domestic economies, governments in countries like Korea, Japan, China, Taiwan and Australia are tasked to implement economic stimulus plans, part of which being infrastructure expenditures to kick-start development projects and create jobs. Relatively aggressive government pension schemes like National Pension Service (NPS) in Korea, the world's fifth largest pension plan and National Social Security Fund (NSSF) in China both have their roles to play in these government-driven initiatives through allocating assets to facilitate infrastructure developments.
NSSF reached a Y5bn (US$73m) agreement with China Development Bank in December on supporting infrastructure construction and livelihood improvement projects.
Meanwhile, NPS reached agreements during 2008 with private equity firms Blackstone, Oaktree Capital and MBK Partners to set aside an aggregate of US$9bn in alternative investments, such as infrastructure, real estate and other domestic investment projects.
To mitigate its vulnerability in equity exposure, NPS trims domestic and overseas equity investments in 2009 to 20.6% from the targeted 29.7%, with 17.0% and 3.6% being allocated in domestic and offshore equities respectively.

GPIF under review
Japan's Government Pension Investment Fund (GPIF), the world's largest pension system, currently allocates 73.01% and 10.47% of assets in domestic bonds and equities respectively with remaining assets roughly divided equally by offshore equities and bonds, leaving its portfolio unchanged as the world's second largest economy suffers from its worst economic performance in 35 years.
Under policies of reviewing investment performance every four years and implementing a new round of asset allocation decisions every five years, the fund will undergo a fresh portfolio restructuring in April 2010.
Topics pertaining to the new investment strategy currently under evaluation include an assessment of its very first venture into alternatives, such as real estate, according to JP Morgan Asset Management Japan's head of strategic investment advisory group Hidenori Suzuki.
"GPIF is very conservative in changing its portfolio. Regardless the outcome of investment decisions, allocation weight in any new classes will be limited, given the huge size of GPIF's assets under management," he said.
Despite any temporary portfolio restructuring in national pension plans following the crisis, mandate managers believe investing internationally will remain the trend.
"The financial turmoil has driven some national pension reserve funds in Asia to review their investment policies and reassess earlier decisions to allocate funds internationally. At the least we expect previous decision to appoint managers will be reviewed in context of the fluctuating circumstances in the financial markets and the reaction by some fund managers to restructure or reduce resources," said Mark Konyn, chief executive officer for RCM Asia Pacific.
"As a result appointments of fund managers for international equity mandates have been deferred for the time being. Nevertheless, we believe and anticipate that the fundamental long-term commitment to invest internationally will remain - it has become a question of timing," he added.
As a general direction, some government pension funds have gradually increased their equity allocation in the past two years compared with the low equity exposure 10 years ago, Ryan of Fidelity International observed.

Fixed income
In the fixed income arena, mandate managers deem US Treasuries to have been and will be a substantial portion in the portfolios of these large funds.
"US Treasuries continue to be a large class in the fixed income portfolios, which makes sense for a number of reasons. A large bulk of Asian revenues is denominated in US dollar because the US is the largest export destination for many Asian economies and exports are chiefly denominated in the US currency. Crucial commodities, be they crude oil or iron ore, are also traded in dollar as well," Ryan illustrated.
"Having said that, many funds are also invested in Euro-denominated sovereign bonds and high-yield Euro credits and this is the case with many institutions such as South Korea's National Pension Service which is arguably one of the more sophisticated investors in the region. They have successfully shifted their offshore fixed income portfolios beyond US Treasuries, resulting mainly from Korea increasing its exports to Europe in the past five years," he added.
A trend worth noting in Asia is a gradual increase of intraregional trade, which money managers argued would affect these pension schemes' fixed income allocation to a certain extent.
Chris Ryan of Fidelity International said: "Intraregional trade has grown strongly in the last two decades and now represents around 20% of total trade for most countries in the region. The other 80% of the trade picture is still with the developed economies of the US and Europe. We see a stronger commitment to regional equity and bond investments forming as a result of these increasing flows around the region and, as a result, better Asian support for local equity markets and deepening Asian local and hard currency bond markets. This should in turn reduce the proportion of ‘hot money' in Asian markets, leading to great stability in the long run."
The crisis also triggered Asian pension funds to address the transparency issue and scrutinise their investments in alternatives.
"One consequence of the problems with alternatives is that pension fund governance will require greater transparency from the managers selected. In conversation with various pension sponsors this will likely see the role of fund of funds reduce and for those plans that can support the governance, single strategy funds will replace," Konyn of RCM argued.

Other investments
On the private equity front, Watson Wyatt's head of investment consulting for Asia Pacific Naomi Denning pointed out that these investments are subject to limits on money they will take on to invest and finding viable investment targets. The larger government pension schemes with investment teams are scouring viable opportunities themselves as well as funding PE firms as funds of funds, she added.
In terms of socially responsible investments, Asia pensions at present are still going through the process of getting portfolios globally invested, which is prioritised over any such investments, albeit that they are deemed by some as offering attractive opportunities."
The demographic trends and future liabilities Asian economies face will determine the direction and asset management approaches of their respective national pension schemes in the long run said Konyn of RCM.
"Japan is an aged society and its retirement investors lack sufficient risk budget to achieve higher returns-return objectives that have been set in easier and more supportive times. The low interest rate and deflation at home oblige the Japanese approaching retirement to save more and spend less. This is reducing economic activity at a time when the economy is in recession and therefore investments continue to disappoint," he said.
"Many pension funds had turned to alternative managers offering absolute return strategies. However many have been disappointed and as a result fund of fund strategies may feature less going forward."
Konyn also point out that Korea is in the process of accumulating savings to fulfill long term requirements although the demographic challenges continue to build.
"In the case of China, this emerging market is different to others in that rather than getting rich and than getting old, China has got old before it has got rich. China has high savings rates and the key will be to mobilise these savings and apply them productively and thereby reduce the burden to meet pension liabilities on the state," Konyn elaborated.
Denning of Watson Wyatt said: "The challenge facing Asia pension funds is how to react to the extreme markets, with one issue being whether to rebalance their equity allocation. Another issue that defined contribution funds need to address is the provision of lifecycle defined contribution options, similar to the target-date retirement funds in the US or the lifecycle funds in the UK which gradually decrease risk as they approach the retirement date. These are not widely available in Asia despite talks in some markets."
Denning also pointed out that national government-run pension funds are not prominent in the West in the way they are in Asia. Sovereign wealth funds (SWFs) like national pension reserve funds throughout Asia are huge and still relatively new to the global investment arena. With their sheer size, getting money to work is a challenge.
Meanwhile, external managers often have limited capacity to take on assets without detracting from their ability to add value. The SWFs are increasingly aware of this challenge and therefore will invest some assets internally or passively. They also have to seek layers of approval to get decisions made and operate under high scrutiny which can make outsourcing quite a slow process, Denning said.

Asset allocation
During 2009, Fidelity's Ryan argued that several forces would drive the asset allocation strategies of government pension funds in Asia.
"The economic stimulus plans already announced by Asian countries will trigger higher inflation which will persist for years and this will drive a move to investing in more real assets such as shares, real estate and private equity. But it will take time to get the right exposures to these asset classes so this will be a long-term process," he said.
Across Asia excess savings have been a consequence of the region's dependency on exports and a reduced risk appetite following the Asian financial crisis. As a result, it is expected that currencies will depreciate as the savings pools will shrink in dollar terms, Konyn of RCM argued.
"This trend will extend to Japan where the reversal of the carry-trade has helped the yen to stay strong despite clear signs of economic weakness. More recently the yen has weakened and we expect the trend to continue for 2009, and across the region. This will impact the attitude to invest internationally."