Enormous changes are taking place in the pension systems of many South East Asian nations. Individual countries are at vastly different stages of development and tackling significant challenges within their own institutions. They are also faced with the effects of a huge regional demographic transformation. By 2050, according to the United Nations, approximately 750 million people in key Asian economies will be over 65. Longer life expectancy and falling fertility rates are having dramatic effects, particularly in China, where the UN estimates that by 2050 approximately 30% of China’s population will be over 60. Declining birth rates reduce the number of children to support parents in their old age. This may shrink the size of the workforce and generate lower tax revenues at a time when reform of pension schemes is critical, given their inadequacy in many Asian countries. According to the World Bank, in low income countries just 10% of the labour force may be covered.In China, the rural population and self-employed (together 70% of the population) fall outside most pension provision, and less than half of urban workers are covered by the system. Where formal pension coverage does exist, many countries have an inflexible structure of statutory retirement payments, and many systems suffer from high evasion and low participation rates. At the same time, many public pension systems in the region have significant liabilities and serious funding problems. Again, one of the most extreme situations is in China, where the legacy of state owned industries leaves the government with a massive pension liability.
Retirement schemes already make up one of the largest and fastest growing pools of capital in the region. Governments are looking towards reform of pension systems to help relieve fiscal burdens as well as contribute to the development of domestic capital markets. There have been significant efforts to improve coverage, including the introduction of mandatory
schemes, such as the Mandatory Provident Fund in Hong Kong, which has increased coverage to 99% of employees and 75% of self-employed people. Many less developed countries have incorporated a mandatory “pillar” into their retirement schemes. Efforts to encourage voluntary pensions savings have been patchy. In China, for example, contributions to enterprise annuities schemes remain low. Critics say that without meaningful tax incentives for companies and employees, savings levels are unlikely to increase significantly.
Pension funds throughout the region are beginning to outsource management of their portfolios (albeit only small percentages of the total) and even lesser developed countries are experimenting with diversifying into higher yielding markets. In the Philippines, for example, the Government Service Insurance System decided this year to hire global fund managers for overseas investments representing up to 12% of total assets. However, most Asian funds remain very conservative in their investment strategies: most funds have no exposure to alternative asset classes and very few would consider an absolute return approach.
Challenges for the pension systems remain in even the most sophisticated markets. Japan’s Social Insurance Agency recently revealed that it could not identify 50 million computerised payment records and that it may have lost millions more. The resulting scandal created huge political trouble for the government. A less dramatic, but still controversial, argument is ongoing in Hong Kong, where there are calls to reform the Mandatory Provident Fund in order to drive down management fees.In other markets transparency is often highlighted, including the lack of clarity in relationships between funds and other areas of government. In Korea, critics claim that the National Pension Fund is used to support the government’s desire to defend domestic companies against foreign takeover bids.
In some countries, social security funds are greatly affected by corruption. China’s National Audit Office recently announced that it had identified 478 billion yuan that had been abused or embezzled by government officials since 2000. The government has made high profile efforts to tackle corruption, including removal of funds from management by local social security officials after a major scandal in Shanghai in 2006. Nevertheless, it is likely that China’s already under-funded system will continue to be weakened by such abuses.
As Asia’s pension funds become more sophisticated, they are likely to consider incorporating sustainable investment practices into their structures and policies. Some individual funds already have detailed SRI policies. Thailand’s Government Pension Fund, for example, is very active and has signed up to the UN Principles of Responsible Investment (UNPRI), a recent initiative encouraging investors to integrate environmental, social and governance (ESG) factors into their investment decisions. The UNPRI encourages “active” ownership and engagement, but pension funds in Asia will encounter a unique set of challenges and opportunities in this area.
Shareholder activism is not common in Asia, although it is beginning in Korea and Japan. Furthermore, practises that work in Europe cannot necessarily be directly
translated to the region.
Investors have also recently been forced to consider the possibility that the booming stock markets may finally be slowing. A liquidity crunch which feeds through into lasting negative effects on Asian markets could change the reform trajectory and encourage the region’s pension funds to rethink their investment policies. It is possible there could be a wholesale retreat to safe assets, confirming the instincts of the more conservative funds and limiting the ability of more progressive funds to secure political approval for future innovations. Alternatively, some pensions schemes may see anopportunity to buy cheap assets. A significant market downturn could also prove to be an interesting test for the UNPRI, which is yet to be widely adopted in the region. Some investors may be able to demonstrate that the incorporation of ESG issues into their investment decisions, and their resulting ability to identify the best companies, has limited their downside risk and boosted performance. Other investors may view these extra-financial issues as a luxury of good times, which should be disregarded when investment conditions become more difficult.
Alexandra Tracy is president of Hoi Ping Ventures