Magazine Issues » April 2010

PENSION FUNDS: breaking new ground

Emerging markets are not just attractive from an investment point of view. Pension funds in these regions are asset rich and global managers can leverage off them as funds diversify internationally. Angele Spiteri Paris reports..


As the power of developed markets wanes, emerging market institutional investors gain importance and are fast becoming one of the most important client segments for global and European fund managers to tap into. At least, once these countries lift the restrictions on foreign investment. But large firms may have more success than small players.

According to Cerulli Associates, a consultancy firm, the Asia ex-Japan region alone will have more than US$370bn (€277.1bn) in retirement assets up for grabs by 2013.

“Intensifying demographic pressure will force Asia ex-Japan to boost retirement assets over the next few decades, creating significant opportunities for global fund managers,” a Cerulli report says.

Ken Yap, Asia-Pacific director at Cerulli, says: “Asia ex-Japan’s investable pension assets will grow by 55% between 2009 and 2013 to more than $1.1 trillion, while addressable assets – which managers can potentially access – will jump even faster, by 75%, to more than $370bn.”

Kwon Oh Seung, head of the institutional marketing at Mirae Asset Financial Group, a Korean firm with $54.1bn in assets under management, says: “Along with the growth of emerging markets, the assets under the management of national pension funds in emerging markets have been increasing and the investment process and tools of those funds have been developed.”

In a pension markets focus paper, the OECD says: “Public Pension Reserve Funds (PPRFs) are expected to play a major role in the future financing of public pension systems.”

And unlike the funds in OECD countries, those in emerging economies have come through the crisis in a relatively good state.

The OECD says: “Outside the OECD, pension funds have shown a more remarkable recovery, even though pension funds in places like Hong Kong (China), Peru and Bulgaria had negative investment returns of over 20% in nominal terms in 2008. Between January and June 2009, the average pension fund investment return in Hong Kong was 12% and in Peru it was among the highest in the world at 18%.

“Other countries which showed an impressive recovery in performance are Chile, Israel and Pakistan. By June 2009, both Chile and Pakistan had largely made up the losses suffered in 2008, while Israeli pension funds had fully recouped the market losses experienced last year.” 

According to the most recent figures from consultancy firm Towers Watson, the largest emerging market pension fund is the Korean National Pension scheme with US$231.9bn in assets under management (AuM), followed by the Taiwan Postal Savings Fund which has $129.3bn, and South Africa’s GEPF with $103.6bn in assets.

These large asset pools gathering in emerging-country pension funds are an obvious attraction for global asset managers. And although few managers were forthcoming in talking specifically about this growing client group, most said these national pension schemes in the emerging markets are becoming increasingly important.

Hendrik du Toit, CEO at Investec Asset Management, says: “National pension schemes in developing countries are clients that are becoming more important. They are different from sovereign wealth funds; they operate more like the big American pension schemes. They have clear rules and smart people.” Du Toit agrees that there is a lot of real money to be managed in these regions (see p22 for the full interview with du Toit).

Guy Henriques, who heads Asian institutional business at Schroders, says: “The industry expertise of the staff in these institutions has risen markedly. A number of emerging market national pension funds have appointed managers who would not only be able to manage their assets but also provide technology and knowledge transfer as part of the service.”

Cerulli research shows that the bulk of the opportunity to manage these pension fund assets lies in North Asia, which contains almost 90% of addressable assets, dwarfing the medium-term potential in Southeast Asia. 

Although the opportunity looks good, the sector is not a place for managers to make a quick buck. Profits from managing money in Asia ex-Japan’s pension sector are currently low and will take time to improve.

Another snag foreign managers may hit is that many of the emerging countries don’t yet allow their government pension funds to invest in foreign assets – and global managers are not about to try and battle domestic managers on their home turf.

Shiv Taneja, managing director of Cerulli Associates, says: “I cannot see foreign managers having much success managing domestic bonds and equities on behalf of these pension funds.”

Conservative pressures
Adrian Blundell-Wignall, deputy director in the OECD directorate for financial and enterprise affairs, and
his colleagues Yu-Wei Hu and Juan Yermo, wrote a paper entitled Sovereign Wealth And Pension Fund Issues, which says: “In many countries, public pension reserve funds (PPRFs) face strong pressures to invest their resources domestically and conservatively… In emerging markets, where institutional investors and capital markets are underdeveloped, it is sometimes felt that PPRFs should help promote domestic investment and financial sector development.”

Wade D Pfau associate professor of economics at the National Graduate Institute for Policy Studies (Grips), agrees. He says: “Historically, emerging market pension funds have not allowed international diversification, on one hand because of the risk of investing in something they are not familiar with, and on the other hand, are more nationalistic concerns.

“They sometimes feel that investing with foreign managers can be detrimental to their country. Therefore, foreign managers looking to break into these markets need to be sensitive to this inclination.”
Taneja, at Cerulli Associates, says: “The restriction on foreign investments is more of a political issue than a cultural one.

“It’s a process. First the pension fund has to stop being managed by the internal department of the ministry of finance and begin handing out external mandates. Since it is a politically sensitive subject, initially, these mandates would be awarded to local managers. The next step is to include foreign managers with a strong local presence, before even considering foreign managers not based in that particular country.”

Taneja says there is increasing evidence of pension funds being separated out from governments. “Pension funds are becoming independent entities, or at least, organisations separate from the government. Although not all emerging markets are moving at the same pace, the general trend is quite similar across the regions.”
This means that these pension funds are getting closer to awarding more external mandates, including those for foreign assets.

Pfau says that international assets could potentially play an important role within the investment portfolios of emerging market pension funds.

This means funds may soon be forced to look beyond their domestic borders – and, in fact, some already have.
He gives the example of the Thailand Government Pension Fund. This fund has been leading the pack of emerging market institutional investors and now has over 20% of the fund invested in international assets.

Taneja says: “The Thais and the Koreans have worked quite hard to make some headway in their views on investment. There is the recognition in those parts of the world that the old way of approaching investment is no longer acceptable and had to change.”

Oh Seung, of Mirae, says: “Korea’s national pension fund is one of the top five in terms of the AuM size. The fund has been increasing its investment in risky assets and diversifying its portfolio. It plans to allocate more than 10% to overseas equities, and another 10% to alternatives, such as real estate and private equities, by 2014.”

But Pfau says: “Many pension funds in emerging countries still don’t allow international diversification. And even those that do don’t necessarily take action. For example, the Pakistan government pension scheme changed the law to allow investment in international assets, but as yet, no allocation has been made.”

As these pension funds continue to grow, they risk flooding their domestic markets and owning too many of the financial assets available. Pfau says: “Going forward they have no choice but to consider foreign investment.

“Once they do open up to foreign investments, there’s a good chance that they will be looking to foreign managers to manage some of those assets. The domestic investment management market is not always very well developed, so it is likely that they will look outside their home borders.”

Going on the Thai example, it seems that foreign managers can attempt to cash in on pension funds looking for alternative assets and strategies.

Pfau says: “The Thai pension fund has been actively searching for international managers within the arenas of private equity, real estate and infrastructure… this could be a trend that will also be seen more generally, especially in light of the growth of index funds. These pension funds can get exposure to equities and bonds relatively easily through passive products. Furthermore, the domestic players are more familiar with bonds and equities than with other more exotic asset classes. So alternatives might be a good area for foreign managers to focus on.”

But Taneja says: “A lot has been said about pension funds investing in alternatives, but even in the developed world, allocations are still relatively small.

“So you could assume that it will be a long while before we see any sort of sizable allocations to these asset classes in the emerging markets. Any allocation made would probably be very small. But they may not follow the same path as developed market pension funds and instead could jump straight into a 20% allocation to alternatives. However, I would say this is quite unlikely, although you cannot rule it out.”

And it seems that alternatives are not the only way in for foreign players.

According to Henriques, of Schroders: “The interest is very broad. We still see considerable interest in global equities and emerging market equities, regional and global. International property investment is increasing and there is good demand for global credit and a growing interest in emerging market debt.”

Oh Seung, of Mirae, says: “Korea’s national pension fund is appointing many global asset managers for the management of the assets investing in overseas countries, especially those that have expertise in their regions. Since it plans to invest money into overseas countries, more global managers will have a chance of managing the funds.”

Low profitability
The move to invest internationally means these funds may be more likely to appoint foreign managers – especially within unfamiliar asset classes. But success will not come easily or quickly. Managers have to be patient.

Taneja says: “Asset management firms that shoulder low profitability now in order to build their links in the sector will probably be in a good position to make the most of the pension opportunity as it matures.

“It’s a question of building relationships and market positioning; but whether a firm should delve into the sector in the first place depends on the scale and nature of its current business operations in Asia ex-Japan.”

Furthermore, smaller players may be at somewhat of a disadvantage when trying to tap into these markets. Experts say that pension funds in emerging markets tend to drift towards the well-established global brand names, due, in part, to familiarity. It’s not to say there aren’t exceptions, but at present this seems to be the trend.

©2010 funds europe