At the beginning of every Chinese New Year, AsianInvestor makes 10 predictions about economic, political and financial developments that are likely to have an impact on the way institutional investors assign their money.

This fourth Year of the Pig outlook looks at the investment targets set by Asia's pension funds and insurance companies.

Have asset owners set realistic investment return targets for the year?

Answer: Yes (for this year) 

With the credit cycle in its late stages and stock markets jittery, investors previously accustomed to the chunky returns afforded by one of the longest bull runs in history have been mulling how best to adjust their strategies and make the most of the existing opportunities.

Of course, some of that pressure may have eased off this month as expectations for further US interest rate rises have been pared.  

But, as elsewhere in the world, pension funds and insurers in Asia face the onerous task of meeting their obligations through the yields generated on their investment portfolios. To do that, it helps to have realistic investment targets. 

And their challenge is made all the harder by the shifting regulatory sands they must navigate in the various jurisdictions in which they operate.

As a media release by Willis Towers Watson puts it, these include the changing "focus in pension design towards a direct contribution model, the growing impact of evolved regulations and further integration of ESG, stewardship and long-horizon investing.” 

The exact level of investment returns that asset owners require vary by country. In Korea, for example, pension funds typically require a minimum annual return of around 4% to 5%, to have enough funds available to keep the funds paying out pensions as more people retire. In Japan, the level is lower; closer to 3%. Those levels should usually be easy to beat, often by several percentage points. And often the funds seek to achieve much higher return rates.

But a combination of very low interest rates in several countries, combined with volatile equity markets, has made making money a more difficult process, as 2018 demonstrated. Japan’s Government Pension Investment Fund, for example, saw its assets fall by $136 billion in the last three months of 2018, from ¥165.61 trillion to ¥150.66 trillion ($1.51 trillion to $1.37 trillion). It was the largest quarterly loss the pension fund had ever experienced and was a testament to its 50% weighting in local and international equities.

The tougher conditions have, on balance, been recognised by pension funds and insurers in Asia, and they have downscaled their ambitions accordingly to match the less certain investment environment, industry practitioners tell AsianInvestor. Return expectations in the low-to-mid-single digits have become a typical target for the year.

ALLOCATIONS

Fixed income and equities still make up the bulk of assets held by pension funds and insurers in the region. In Australia and Japan, specifically, about 63% and 85%, respectively, was allocated in 2018 to bonds and shares, according to an annual survey by Willis Towers Watson.

One likely change that industry experts expect Asia's pension funds and insurers to conduct is a scaling back of their global and plain-vanilla bond strategies. With central banks on balance now withdrawing stimulus – the European Central Bank has halted its $2.95 trillion (€2.6 trillion) bond-buying programme, just as the Federal Reserve slowly shrinks its balance sheet – they will no longer be a source of structural support for the market.

On the equity side, experts predict another leg-up in return-seeking assets if the US Federal Reserve holds off from raising rates and US-China trade tensions dissipate, even if that helps reset the interest rate cycle further down the road.

As pension funds and insurers consider how to best adjust their investment targets, it’s worth noting that industry regulations and demographic needs could affect their plans.

The incoming IFRS 9 accounting rules are a recent driver that prompted Asian lifers to deploy fewer and larger investment mandates in order to improve cost and operational efficiency, for example. Meanwhile, risk-based capital II rules will affect the type of assets insurers find most appealing.

Pension funds and insurers will need to balance investing into asset classes they think can offer the best return in an uncertain environment with restrictions onto their investing plans such as regulation, accounting and regulatory requirements.

And while the asset owners appear to be realistic about their investment targets this year, this may not prove to be the case over the longer term – especially if a ‘lower for longer’ return environment persists, as many fund managers and consultants predict. 

Previous Year of the Pig predictions:

Will the ETF Connect finally open? 

How much will Asian asset owners increase alternative asset allocations (on average)?

Will the US economy suffer a major downturn?