Institutional investors are increasingly hungry for yield, but restrictive rules are hampering the ability of those based in many emerging Asian economies to hunt it, reducing their potential returns and possibly storing up problems for the future.
AsianInvestor spent several weeks interviewing institutional investors from the region's developing nations. One overriding factor emerged: funds are increasingly having to look outside their comfort zones to invest.
Larger pension and sovereign funds around Asia Pacific are increasingly weighing up how much of their assets to commit to traditional, low-risk asset classes – typically domestic government bonds – and to what degree they should expand into newer instruments and new geographies.
Although markets are not necessarily returning to normal patterns of behaviour post-quantitative easing, Paul Colwell, chair of the advisory portfolio group at Willis Towers Watson, said the investment environment had changed, throwing up opportunities for those funds quick-footed enough to adjust their stance.
“If we look back over the last 20 to 30 years, you’ve had this general convergence of economies, inflation rates, bond yields,” he said. “Looking forward, we have passed that peak and are now going towards a more divergent world where we have significant changes of domestic market growth levels, different inflationary environments, and massive [currency] moves."
"We’ve had step changes and this feels like a reversal,” Colwell said.
In those circumstances, there could be good reason for investors to look at regional and sector asset-type thinking, which the industry had been moving away from in favour of a global approach.
Shifting into new asset classes requires additional expertise, in-house or outsourced, plus a willingness to embrace new concepts and risk. In more developed regional centres and among sophisticated sovereign wealth funds, that is already happening.
“There are institutions in Asia that are building up sizeable teams to cover private markets, alternative strategies, or even their equity and bond portfolios,” Colwell said. “They are hiring or they have plans to hire large numbers of people, and a lot of that is to help with implementation.”
Outside Australia and New Zealand, though, such moves have been very limited to date. Asset owners from less developed nations, particularly on the Indian sub-continent and Southeast Asia, are especially reluctant to place money outside traditional markets, increasing the risk they fall short of performance targets as global returns dip.
Across developing Asia, pension funds are often state-linked and dominated by civil servants on rotation. Governments also impose bureaucratic constraints on their investing ability.
Perhaps the biggest issue is complacency: most economies across Southeast and South Asia have enjoyed relatively stable economic growth, so the need to scale up investment departments is not seen as important as elsewhere in Asia.
Sri Lanka’s Employees Provident Fund, a defined contribution scheme, is one such example. The Central Bank of Sri Lanka oversees its LKR1.7 trillion ($12 billion) of funds and invests all assets onshore, with 90% going into government securities. It has only 5% in equities (against a 10% cap) and has yet to invest in funds listed on international exchanges, despite having permission to do so. The central bank knows it needs to diversify, given the EPF’s huge size relative to Sri Lankan financial markets.
As Ananda Jayalath, assistant governor of the CBSL, told AsianInvestor, it has no desire “to get into the management or to hold a controlling [company] stake.”
In some respects, the Sri Lankan EPF’s conservative approach to investing makes sense in the current climate, with government securities paying a coupon of 13% and Sri Lankan inflation relatively stable at around 5% to 6%. But Sri Lanka has an aging population, so the fund will increasingly rely on strong investment returns to grow, which cannot be guaranteed at home.
CBSL is mulling investing in India and beyond, but a strong home bias lingers for now. “We will need to build internal capacity before we move into other areas,” Jayalath said, offering no timescale on when the central bank’s investment policy might broaden. “That’s the main reason we are sticking to local currency assets.”
Caution over hasty asset diversification also characterises India’s largest retirement fund, the Employees’ Provident Fund Organisation (EPFO). On March 30, its trustees deferred discussing a proposal to increase its investments in exchange-traded funds from 10% to 15%, at least until its next review at the end of April. It seemed an odd decision, given the 18% total return generated by its ETF investments from August 2015, when the programme started, to February this year.
EPFO has faced resistance from trades unions to plans to invest in equities – unions think doing so is too risky. This and the fact pension fund officials are often reluctant to do anything too radical for fear of failure (so-called career risk) compound the inertia on investment policy.
Meanwhile, plans for a sovereign investment vehicle in the Philippines, slated for introduction in mid- 2017, appear to be on the backburner.
For many asset owners in emerging markets, regulatory inertia and a lack of prioritisation over allowing offshore investment is proving an intractable issue. It's something that governments may well wish to reconsider, if they are to ensure their own people enjoy the retirement savings that they will need in the years to come.
This is the first part of a feature in the April/May edition of AsianInvestor. Look out for the second part of this story in the coming days, in which we look at emerging market asset owners that have managed to begin expanding their investment horizons.