Asian public pensions lag global peers in diversification

Despite a major reallocation of assets by public pension funds over the past decade, Asian public pension funds (PPFs) are lagging their global peers when it comes to asset diversification, according to researchers at State Street.

There is also a divergence in allocations between North and South Asia.

Data compiled by researchers in the Official Institutions Group at State Street shows that public pension fund assets grew by 40% in dollar terms between 2008 and 2016. At the end of 2016, they held around $5.9 trillion in total assets and over 4% of all publicly traded assets.

Roughly half of the assets in its sample of 115 funds originated from Asia-Pacific countries, of which half was Japan's.

Looking at data from 2008 to 2016 they observed a number of patterns, including a significant rise in equity and alternative allocations globally over the period. The share of equities rose by 8.3 percentage points to 28.2% while alternatives went from 11.7% to 16.2%.

But the high number of individual Asian funds with over 90% still invested in fixed income shows the region still has a long way to go to converge with average global PPF allocations, particularly in the south of the region, says Alexander Petrov, a member of the Official Institutions Group at State Street Global Advisors (SSGA).

Funds in the Indian subcontinent and Southeast Asia “are at an earlier stage in terms of the breadth of their portfolio,” than even their peers in north Asia, he told AsianInvestor.

"There are still large funds with over 80% of assets in a mix of cash and domestic government bonds. Most of them have plans to expand into riskier and more geographically diversified assets, and some have started to do so already,” Petrov said.

Some PPFs can ignore actuarial sustainability in the short term, he said, as they effectively benefit from a government guarantee and can theoretically run their assets down to zero.

“This may prevent them from making forced investment decisions with suboptimal timing, but also weakens their financial discipline and creates complacency on the government’s side,” he said.

Taken at face value, one of the "surprisingly unsophisticated" funds is the Singapore Central Provident Fund (CPF), Petrov said, because it invests almost fully in domestic government bonds.

"The majority of their allocation is not even to the normal government bonds, which trade in the market, but special-issue government bonds, which provide it with a guaranteed hedge against inflation. So yes, the government attempts to offset their liabilities almost directly, so there is a slightly artificial element to CPF."

That may seem strange, he said, until you see that Singapore has many other balance sheets. "So in a way the government earns a high rate of return from GIC and Temasek, while the pension fund is provided with something akin to a guaranteed return."

The contrast between PPFs in north Asia, particularly Korea and Japan, which have expanded their global allocations and adoption of alternative assets, is understandable, Petrov said. "You have to remember that Japan and Korea have developed much earlier, so there is a maturing that has happened there."

The greatest variation among PPFs is in their attitude towards alternative investments.

Many Asian PPFs have not started investing in alternatives at all and Petrov notes it is no coincidence that the ‘arms-length’ public funds, where the government keeps its nose out, hold higher-conviction assets than funds which operate under tight government control. 

MALAYSIAN EXCEPTION

In Southeast Asia, Malaysia is the exception.

"They have been running some fairly sophisticated public pension funds for some years. They have been investing in alternatives in some cases for over a decade," Petrov said. "Malaysia is really in between, because if you look at the asset allocation of the Employees Provident Fund, it’s very close to what you see in north Asia."

Malaysia aside, SSGA doesn't expect the divergence between North and South Asia to continue.

"If you look long term you can see that everyone is travelling along the same path and even the very traditional funds like India’s EPF or Singapore’s CPF are starting to allocate to equities and corporate bonds,” Petrov said.

He thinks that while there will always be changes in the dynamics of the region in the short term, “in the long term, we project there might actually be some convergence, because they all ultimately face the same actuarial issues, even though at different degrees of acuteness. Therefore, we think they will end up more similar than they are now."

Demographic changes and local market development will play a part in this regional dynamic, he said. "Some countries [in Southeast Asia] will develop their capital markets further, which will increase the appeal of domestic equities. But at the same time, societies are aging and in principle the pension funds should diversify away from this aging workforce and have a wider geographical reach. So how these factors interact with each other will be interesting to see, and this will be reflected in the sub-composition of their equity allocations."

Chart: Average % share of alternatives in public pension funds

This story has been updated