Asia’s asset management hot spots

Cerulli Global Edge, February 2013

Asia’s hot spots are not what they might first appear. An apparently simple picture is actually very nuanced: high economic growth does not necessarily mean high addressable assets; large institutions do not automatically equate to large outsourced mandates; and high populations are not always synonymous with a strong retail opportunity.

Take China. It is, clearly, the engine of world growth, and will one day be the world’s largest economy. It is also now the largest institutional market in Asia ex-Japan, with US$4.4 trillion of assets in 2011, almost half of the entire regional total. And clearly there are enormous opportunities for fund managers here. But the numbers don’t tell the whole story: 72% of China’s figure is made up of the assets of the People’s Bank of China, mostly not addressable by foreign managers. Yet Korea – while far smaller than China with a US$1.1 trillion institutional market, and considered far less of a growth engine because it is a mature economy with long-term worries about ageing demographics – is arguably more of a hot spot for fund managers than the far more feted China, because many of its investors, such as the National Pension Fund, Korea Post and the Korea Teachers’ Credit Union, are boosting their allocations to overseas assets and alternatives, and are seeking foreign help to do so.

Another example is the behaviour of sovereign wealth funds in the region. Since they are all growing impressively, one would think this would represent rich pickings for asset managers, but it’s not necessarily the case. The most evolved funds, Singapore’s GIC and Temasek, have all but stopped giving external mandates out except in very specialist areas, particularly alternative investments. Newer funds, such as the Korea Investment Corporation and China Investment Corporation, have started out with heavy outsourcing of mandates while they have grown expertise internally, and then started to take things back in-house again – this is increasingly clear in Korea, for example. Still, in these newer funds, particularly China, the pace of growth of assets means that the opportunity for foreign managers remains very high, even if the percentage of outsourced assets is declining.

So where are the opportunities?

Well, one hot spot across the region is the pension fund industry – less prevalent in the headlines than sovereign wealth funds, but increasingly a better candidate for mandates. A Cerulli report in 2012 polled asset managers, who said that pension funds would be the most profitable element of their institutional business in 2015, followed by central banks and quasi-government organizations. Pension funds are large and getting larger; are willing to engage external managers; and are starting to move into riskier assets such as equities and alternatives. Generally, Asia ex-Japan pension funds are still in their asset accumulation stage, so member contributions and investment income should continue to be powerful forces for growth; Korea’s NPF, for example, even in a mature market, is receiving net inflows of KRW16-17 trillion (around US$14 billion) a year.

Again, big isn’t necessarily best here. The country or state with the highest level of institutional outsourcing, by far, is Hong Kong, a much smaller market than China, Korea or Taiwan; its institutions outsourced nearly 35% of their assets in 2011, because its two major pension funds – the Mandatory Provident Fund and Occupational Retirement Schemes Ordinance – are addressable to asset managers through mutual funds.

Outside the more developed markets, the emergence of pension industries also represents a huge opportunity. This is perhaps the single greatest area for foreign fund manager opportunity in China, for example, where pension fund assets have grown by a CAGR of 20.1% between 2007 and 2011, the highest rate of growth in the region. China’s National Social Security Fund is an active outsourcer to foreign managers – and, unusually, makes it public when it does so – and more broadly the advent of a corporate pension industry has enormous potential for asset growth.

Other hot spots are individual markets.

In southeast Asia, where Singapore has traditionally dominated institutional assets, there are clear signs of smaller economic powers gathering steam. Singapore accounted for 58.7% of southeast Asian institutional assets in 2007, but just 48.2% in 2011, not because Singapore itself is shrinking but because other states are growing. For example, the Philippines has grown from 8% in 2007 to 12.4% in 2011 as its institutional assets have doubled, albeit off a low base. Thai institutional assets showed compound annual growth of 17.3% between 2007 and 2011, and grew 18% in the last of those years. Behind those numbers are other interesting shifts that create opportunity: both Malaysian and Thai pension funds are diversifying portfolios overseas and into alternative asset classes, and hiring external managers in order to help them do so. Even in Vietnam, one sees the national social security fund seeking to diversify its investments into public equities and overseas assets, although doing so would require a change in rules.

There is clear opportunity there, and for the future, perhaps especially Indonesia – the largest country in the region by population, and the darling of emerging markets in recent years as it has combined a strong domestic growth story with resilience to global shocks and a stable government. But, once again, economics and population aren’t everything.  Indonesian institutions are still mainly conservatively invested. And at the far extreme, India – on track to have the world’s largest population when it inevitably overtakes China – still represents a very limited institutional opportunity; until recently, fund managers for private sector participants in the National Pension System could only charge 0.09%, a figure recently increased to 0.25%, still a prohibitively low figure for many international managers.

Some managers are looking further along the frontier spectrum. Resource-rich nations such as Mongolia, Papua New Guinea and East Timor all have either built sovereign wealth funds or are making progress in developing them, creating opportunities for external asset managers. Also, Asia’s bigger sovereign wealth funds, such as Temasek and the China Investment Corporation, are increasingly interested in private equity-style investments into frontier markets, including Mongolia and many resource-rich African nations.

While it might seem logical to see emerging and frontier markets as the next great opportunity, in fact asset managers are still likely to find richer pickings in more developed states. In Taiwan, for example, total outsourced assets increased at 11.5% between 2010 and 2011. And, given how entrenched the institutional marketplace is in Taiwan, these are big numbers: The Labor Insurance Fund alone increased its total outsourced assets by NT$21.3 billion (US$700 million) in the first quarter of 2012, and the Labor Pension Fund’s new scheme outsourced 52.8% of its investable assets.

Why should this be the case? One reason is that in a developed market like Taiwan, the sums in the pension industry are so big that they can’t all be invested in domestic capital markets. That makes overseas allocations unavoidable, and consequently, external advice too.

For the future, hot spots may be thematic – like infrastructure, Asia’s greatest shortfall and impediment to development. There is no shortage of appetite for infrastructure investment on the part of major Asian institutions, particularly sovereign wealth funds, who are attracted to the long-term steady payment profile, mirroring their liabilities. But the challenge for fund managers is finding a way to get involved in what is largely a direct investment play. Singapore’s GIC, for example, allocated 11% of its assets to infrastructure and private equity as of March 2012, but the infrastructure side of that is mainly done through direct investment.

Even if infrastructure is hard to take a piece of, investment managers will increasingly be required to be specialist and innovative in the ideas they put to major institutions. While there is still room for index replication strategies, institutions are less and less willing to pay up for active strategies that broadly mirror a large benchmark, such as US equities. Institutions want to pay for alpha, often in extremely specific areas, and if not, then in areas where there is real potential for outperformance such as emerging markets equity and debt (Korea’s NPF and KIC, China’s National Social Security Fund, Singapore’s GIC and Taiwan’s LPF all gave out mandates in these areas in 2012). Not only are mandates more plentiful in these areas, they pay better, too: an emerging market equities mandate from an Asian institution might pay 40 to 80 basis points, compared to 5 to 20 for local fixed income. Private equity funds are among the few remaining areas of asset management where the 2 and 20 fee structure is still accepted. Cerulli notes hourglass characteristics in the Asian mandate universe: very specialized, such as absolute return Taiwan equities, or index-driven, such as minimum volatility global equity index – both of them real examples of mandates given by Taiwan’s new Labor Pension Fund in 2012.

On the retail side, some curious dynamics are at work. In Asia ex-Japan, total assets under management in mutual funds have shrunk considerably in recent years, from $1.14 trillion in 2007 to $1 trillion at the end of 2011, despite the fact that the number of funds themselves has grown. Cerulli does expect modest growth in mutual funds in the years ahead, but it’s not an altogether healthy picture: in China, for example, the average AUM in open-ended mutual funds has fallen from US$1.4 billion per fund in 2007 to $322 million in June 2012. It’s true that many retail assets are more profitable than institutional mandates, but it comes at the cost of administration headaches and considerable churn.

Retail, though, brings us to another hot spot: the rise and rise of exchange-traded funds (ETFs). In Asia ex-Japan, these vehicles recorded a compound annual growth rate of 23.9% between 2007 and the end of June 2012. In China, Hong Kong, Singapore, Taiwan, South Korea and India, there were 51 ETFs in 2007; that figure had risen to 268 by June 30 2012.

While those figures sound impressive, it is important to realize that even now, if you put all of Asia’s ETFs and mutual funds together, ETFs make up only 5.3% of the pie. While that is strong growth compared to 1.8% in 2007, it’s still a modest contribution relatively.

The big question, therefore, is just how big they can get. There are managers who believe that the recent rates of growth can be sustained for several more years, in which case building successful ETFs is extremely good business sense despite the low fees; but at the same time, it’s certainly not the case that all new ETFs have attracted assets, with the bulk of funds tending to be dominated in a few key products that appeal to retail and to financial advisors.

Also, it’s not yet time to sound the death knell on mutual funds, whose shrinking performance in recent years has been partly a consequence of equity market performance and partly capital flight. There is, however, continuing interest in mutual funds that offer income and yield – often equity funds focusing on dividend stocks, for example – and they remain very much a boom area at a time when government bonds are tending to offer such low yields.

There are instances where regulatory change can create a hot spot. For example, the China Securities Regulatory Commission has relaxed fund application rules so that managers can submit applications across three asset classes (equity, debt, index) for approval simultaneously. And securities companies can develop and sell products without the regulators’ prior approval. In Taiwan, as cross-straits relations have thawed, onshore managers are now allowed to invest fully in Chinese securities for the first time, and can now have multiple currency share classes, allowing domestic managers to raise assets overseas.

In terms of distribution, for some years now the hot spot has been the private banking channel. In Hong Kong and Singapore, and to an extent Korea, more and more fund managers target this channel. Partly this is because retail bank distribution can be difficult, as regulation has intensified on banks and what they sell. Also, of course, it brings access to high net worth clients, and private banks tend to carry a wider range and number of products than other channels. They are more likely to sell (and to be permitted to sell) more exotic products such as alternatives, themed funds and RMB funds, and the client base tends to have a higher and more sophisticated risk appetite. Additionally, while private banks select funds in the same ways as retail banks, they tend to be more open to boutique fund managers.  In future, we are likely to see Asia-based fund managers create dedicated roles for people to serve the private banks; Aberdeen Asset Management and Legg Mason are two examples of institutions that have already done so in Singapore or Hong Kong.

In some markets, insurance distribution is becoming a hot spot too; Cerulli research finds that Hong Kong and Taiwan are the markets where fund managers have the greatest enthusiasm for this channel. Investment linked products sold through insurers tend to be sticky and provide insulation from the churn commonplace in retail bank distribution.