ATC Business Casual
Author: Sun Wei, Founder of ATC Initiative
Working on Allocate to China (ATC) Initiative would inevitably get me involved in the frequent debate with European investors on “Why China? Why allocating to China NOW?” It is particularly the case in these days when people can easily provide quite a few arguments for NOT to allocate to China now. For instance, lower growth rate, US-China trade tension, housing market growth slowdown, etc. But what I found interesting is that many of the cited reasons for not investing are actually, with a bit more exploration, reasons for increasing the allocation to China.
- The concern over lower GDP growth rate (by China standard) has resulted in government rolling out tax reduction and other pro-business measures, benefiting the private sector.
- There is a clear consensus in China that the best approach to deal with the US-China trade tension is to continue to open up, making China more investor-friendly, as evidenced by the recent measures and legislation on capital market access and foreign direct investment.
- The cooling down of the real estate market is in fact a direct reason why Chinese equity and bond market become more attractive. A few years ago when investing in property (or the private lending market related to real estate development) could easily offer a 15-20% return, with very limited perceived risk, many investors could not find any reason to deploy their capital to stocks or bonds. Now capital flows to equity and debt and helps to fuel businesses in “real economy” …
But I would like to tell another argument for allocating to China which is not that obvious but no less fundamental than any of the above. I refer to the ongoing pension system reform in China.
People like to mention the “80/20” phenomenon when comparing Chinese equity market with the mature markets: (roughly) 80% of the trading in Chinese stock market is done by individual investors and 20% by institutional investors. It is (again roughly) the opposite in a mature stock market in western countries. This dominance of individual investors in China equity market, to a large extent, leads to many “emerging market features” such as high volatility, herd behaviour etc. and makes the international investors pause for a second thought before entering the market.
This has been a well-recognized issue with Chinese regulators who have tried various measures to encourage the development of institutional investors and “institutional investor mentality”. Among these measures, I would believe that the pension system reform is promised to make a major difference.
China has the world’s largest population and it’s ageing. For a sustainable society, China is in urgent need of a well-functioning pension system. Currently, the Chinese pension system is very insufficient. Total pension asset is roughly at the level of RMB 11trillion, with pillar 1 asset (Social Security Fund, SSF and Public Pension Funds, PPFs) accounts for 70% of it, pillar2 asset (Enterprise Annuities and Occupational Annuities) accounts for 20% and pillar 3 assets (commercial personal pension insurance) takes the rest of the pie(10%). Total Chinese pension asset is around 12% of GDP (to compare: US@131%, UK@121%, Japan@63%, HK@49%, source: Willis Towers Watson), and it heavily relies on the government-run first pillar (to compare, US pillar 1/2/3 asset ratio is roughly 10%:55%:35%). Hence there is a huge growth potential for Chinese pension asset and the biggest growth will come from the 2nd and 3rd pillar. KPMG estimates that by 2025, total Chinese pension asset will reach the level of RMB 45trillion, a 25%+ annual growth rate.
That is what is happening: in the 2nd pillar since the introduction of occupational annuities (mainly for public sector employees) a few years ago, it has experienced very rapid growth, which is expected to spur the growth of the somewhat stagnating enterprise annuities. Most exciting development happens in the 3rd pillar when new laws and regulations have enabled tax deferment benefit for pension products. Many insurance companies and mutual fund managers have participated in new product offerings.
Why do I think pension growth in China will be a game changer for its capital market?
- Pension asset has the magnitude and clout to change the landscape of the whole investor structure in China, leading in the transformation of China capital market into an institutional investor dominated one.
- Pension investment intrinsically thinks long-term and values professional skills. The Social Security Fund has set up a good example in long-term asset allocation, selecting best of breed external investment managers, and carrying out global diversifications by mandating overseas managers. Second pillar pension asset has adopted similar risk management/manager selection mechanism as Social Security Fund. Pension funds will lead the evolution of investment mentality among institutional investors.
- The 3rd pillar products also help educate individual participates in risk awareness and long-term consideration. For instance, in the past year, 28 mutual fund managers have got approval for their launching of 40 pension fund products in the form of Target Date Funds or Target Risk Funds. These target date funds have the expected fund longevity in their names—20, 30, 40 years! Many individual investors would for the first time think that long into the future when they purchase the product and that thinking will hopefully be always in their mind.
- The growth of pension asset will affect industry development as well. The concept of fiduciary duty will be embraced by Chinese pension funds. For instance, Social Security Fund has now actively considering the ESG factors in their investment and a friend of mine has set up a successful governance consultancy in helping pension funds and other institutional invest on proxy voting and other governance issues. These development will continuously improve the sustainability and invest-ability of Chinese firms!
For the above reasons, I’d encourage anyone interested in China capital market to join the “China Pension Reform and Long-Term Investment” Seminar organized by ATC Initiative in collaboration with KPMG in London on 5th April and learn more about the exciting development in the Chinese pension system.