Thursday, April 22, 2010



When analyzing the possibilities of developed nations in the next 10 years or so, most observers seem to be quite negative. Sure, growth rates in Emerging Markets are higher, labor force younger, wage levels lower. Financial capital is not really that much of an advantage any...more with sovereign wealth funds in China and the Middle East now having the funds to invest in their own markets. With respect to other areas of knowledge advantage that the West still has human capital is also to a certain extent transferable. Growing herds of skilled personnel moved towards the Middle East and Hong Kong. And the other way round, larger percentages of skilled students from emerging countries that were sent to Western universities are now indeed returning to their home countries. I.e. the traditional brain drain is getting less severe now that local markets provide bright youngsters with better career opportunities.

Our 'forgotten' industry: Pension Funds

Pension Fund Industry: Golden Egg with Export Potential?

But one industry seems to be totally forgotten. I would almost say 'As always'. And that is the pension fund industry. The pension fund community is still far larger than the combined wealth of wealth funds. And with Western observers always complaining about the lack of transparency of big wealth funds in the Middle East and China, we could just as well ask ourselves the question: Why are negotiations between governments of developing nations that need financial capital still held between governments and internationally-operating banks on the one hand and receiving governments and/or large state-owned enterprises and/or international aid distributors on the other? Where are the pension plans or asset managers representing them? Aren't they the ones with the money? Governments in the West are struggling with deficits and in many countries populations indicate in surveys that - if anything - they want development aid levels to be reduced now that some belt-tightening is required.

Combining this with Dambisa Moyo's work on Economic Support instead of Aid, we could say that pension plans are missing out on interesting opportunities to take the lead through a more proactive stand. Their focus seems to be on coverage ratios and local problems. Actually: they even seem to panic in many instances, especially in countries with a Defined Benefit system like for instance the Netherlands.

But aren't they exaggerating? On the one hand coverage ratios will improve when interest rates will move up again. They are at historical lows and with the value of liabilities being calculated as the NPV of future payments to pensioners it is logical - with durations of liabilities on average higher than duration of assets - that low interest rates translate into large liabilities and therefore low coverage ratios. When inflation levels move up and nominal interest rates increase, things will most likely actually improve even when asset returns will suffer in that kind of scenario. True, this is not the whole story because we also need to take into account changing demographics. Another ratio is more worrisome, namely the percentage of retirees versus the number of people contributing premiums. And to make things worse: the average retiree is now also living longer than before (longevity risk).

But why is no one looking at the pension industry as a REAL industry? I.e. one that is producing a product, pensions, that might be of growing interest to emerging markets. In the Emerging Markets labor forces are relatively younger, i.e. with the bulk of people there who might be interested in a pension scheme being net premium payers for many years to come. The pension business is also not a simple one. Efficient structuring of the pension management, administration, asset management and liability management requires experienced professionals, software systems and financial infrastructure. Something that most Emerging Markets don't deliver yet. And something that is not really exported large scale. Life insurance providers seem to be leading the pack with Defined Contribution like products. But, with upwardly mobile middle classes in developed nations still - on average - earning far lower and probably even more uncertain/volatile incomes as well, it is highly likely that Defined Benefit based systems like the one we have in Holland are quite interesting to successful emerging markets that see improvements in the quality of life and wealth levels of growing middle class populations.

Western governments of countries with strong pension system are missing out on a very interesting opportunity. And not just them. Pension Fund top management as well, because they do also have the opportunity to act in a more pro-active way without government support. Talks with financial insiders from emerging market countries do indicate that they are more than interested in this Western hidden export product. And don't think that it is a small niche market that we are talking about. Just to give you an idea: the Dutch pension market is larger than our nations GDP and we are - and that with a population of just 16 million people - the fourth largest pension market in the world.

OK, we should worry about negative demographic factors. But why not at the same time trying to expand service with new business from across the globe. Business from areas with by definition better coverage ratios AND ratio of working members to retirees.

 Isn't international expansion of pension funds too risky?

Critics might comment that mixing premium bases in different countries/regions vis-a-vis a retiree base that is basically for 100 percent in one of the regions might imply more risk. However, due to globalization trends and due to larger growth rates in developing countries that now seem to translate into an - on average - positive development of their currency levels vis-a-vis western currencies, this risk is more than manageable. And the alternative: continuing the way we do with a purely domestic approach would likely lead to higher risks and higher premiums.

Last but not least: strong, internationally operating pension plans would also represent growing competition with insurers and banks, and after the crisis we all know that this is already a benefit in-and-of-itself.

Conclusion: it is almost inevitable that the West will lose GDP and market share to emerging nations and their strongest firms. But when accepting that fact, we should make sure that all options available to us to stimulate export to these nations are used. It is strange that one of the biggest ones remains totally unused.

1 comment:

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