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Research Papers 13-04 Jan. 29, 2014
- Research Topic Asset Management/Pension
- Page 356
Part 1. Building the lon-term Vision
I. Problem Diagnosis
Most of economists will agree that the most serious challenge ahead of the financial industry including the asset management industry is how to properly understand and respond to the realities of an aging society, low-growth, and low-rates in Korean economy. From the perspective of the financial industry, population aging basically means a structural change on the demand side. The fundamental questions here are how the change will affect households’ asset demand, or more specifically, to what extent the change will increase or decrease that demand. How will it affect the demand for financial assets, and how it will impact risky assets? Depending on the answers to these questions, population aging which is commonly perceived as a risk factor in the overall financial industry may create new business opportunities. Hence, the focus of the nation’s financial industry strategy should be on how to overcome and address the risk factors.
On the other hand, population aging is coupled with a major shift as household income moves from labor towards pension benefits. In other words, a big chunk of the overall household income will not be generated in exchange for labor. Instead, the size of the income will largely depend on the management of pension assets by asset management companies and the overall financial industry. This trend will create new business opportunities for the asset management industry.
Due to the challenges posed by the aforementioned change, the role of the asset management industry in the overall financial industry will receive renewed attention and evaluation. Efficient management of pension assets and consumer-oriented (pensioner-oriented) financial service system are consistent with Korea’s drive to advance the asset management industry. While the former goal can be achieved by the superb management capabilities of asset managers, the latter requires the expansion of consumer-oriented pension asset management services.
In this study, we first set up the future vision of the asset management industry as an efficient financial infrastructure to support an aging society. Then, we provide the future outlook for pension and asset management industries, and finally draw out key challenges to accomplish the vision.
Ⅱ. Social and Economic Changes
From the viewpoint of consumers, population aging may increase life expectancy and thereby expand their demand for financial assets and management. But whether the demographic change (the increase in the old age group) will increase the withdrawal of financial assets for post-retirement life and thereby increase the aggregate financial asset demand requires further empirical analysis.
Low growth primarily results from lower labor input due to population aging. This can decrease the overall investment returns because it also cuts the average returns of the national economy. Hence, it is necessary for Korea to explore innovative investment opportunities to facilitate privately placed funds supplying risk capital. At the same time, overseas investments should be expanded especially in high-beta regions in order for efficient lifetime (pension) asset management.
On the other hand, low rates mean the natural decline in the equilibrium interest rate due to low growth. Arguably, this will lead households to prefer risky assets. Although it is obvious that low rates will cause a shift from safe assets to risky assets, the extent of the actual shift is closely related to investor confidence over the capital markets and the industry’s revenue generation capability, which requires institutional and strategic actions.
In light of Japan’s case, which experienced aging, low-rate, and low-growth before Korea, and considering Korean households’ higher holdings of physical assets than financial assets, the current low-rate, low-growth trends are forecast to positively impact Korean households’ financial asset demand.
Furthermore, as confirmed by Japan’s experience, financial markets will be led by pension funds in the future. What is necessary now is innovation in both investment strategies and market institutions so that pension asset management can maximize asset values for pension beneficiaries.
Ⅲ. Future of the Asset Management Industry
1. Quantitative Outlook
Despite the low growth, Korea’s asset management market is expected to grow continuously for several reasons: the capital shift from physical assets to financial assets, higher allocation to risky assets due to low rates, and the virtuous circle between the asset management market and institutional investors including pension funds. Korea’s asset management market is expected to grow from the current KRW 660 trillion level to KRW 1,654 trillion ~ KRW 1,814 trillion in 2020, which is more than a 20% compound annual growth rate.
This will make the asset management industry even more important in the national economy. The industry accounted for 47% of GDP in 2012, but this figure is expected to exceed 80% in 2020, which is lower than the US (290%, publicly placed funds only) and the UK (270%) but higher than Japan (33%), Germany (60% in 2010), and close to the EU (104% in 2010).
Presumably, the high growth will be driven by discretionary investment advising (KRW 1,143 trillion in 2020) as opposed to funds. Two factors support the forecast: first, discretionary investment already surpassed the fund market in terms of size, and second, the current trend will accelerate if the rapid growth of pension funds facilitates institutionalization in the capital markets.
The high growth in discretionary investment is associated with the fast increase in institutional investors’ asset holdings. Currently, their AUM stands at KRW 1,200 trillion, similar to Korea’s GDP, but is forecast to grow further to KRW 2,867 trillion ~ KRW 3,675 trillion in 2020. This is 1.4 times ~ 1.7 times of Korea’s GDP and is close to the current OECD average (160% in 2010). Among institutional investors, public pensions are presumed to grow threefold to KRW 1,265 trillion by 2020, retirement pensions and private pensions increase twofold, thus driving the growth of institutional investments.
2. Qualitative Outlook
A. Income safety net
Pension assets flow to the asset management market because the asset management industry is the core source of extra returns under the low-growth, low-rate environment. In the aging society, the asset management industry is expected to function as a safety net to create stable post-retirement income because it amplifies the long-term value of pension assets by providing tools for investment exit, inflation hedging, and higher returns.
B. Backbone of financial intermediation
The rapid growth of the asset management market will facilitate the high growth of financial intermediation through funds and discretionary investment advising. This means that asset management industry is expected to play a pivotal role in the financial intermediary system. While the proportion of intermediation through funds or discretionary investments in the equity and debt markets is forecast to climb significantly, a persistent downward trend is expected in financial intermediation through bank deposits under the current disintermediation trend. This tendency will raise the industry’s contribution and enhance the value of the whole financial industry, and accordingly increase its weight in the overall labor market.
C. Strengthen support for the real economy
The asset management industry is an ecosystem where venture funds, private equity funds, hedge funds, and other alternative investment funds operate in order to supply risk capital to innovative businesses, to make markets, and to facilitate restructuring. Under the current low-growth economy where good investment opportunities are rare and restructuring is delayed, the industry is expected to play a pivotal role in innovative financing, which means exploring innovative investment opportunities and injecting funds. More specifically, the industry will push up saving rates by providing returns higher than the interest rate, and facilitate investments by injecting risk capital into companies.
D. Investor-oriented, open distribution channel
Open distribution channels are gaining popularity globally, and this will affect Korea as well. Korea is expected to see more distribution channels develop into open channels. Accordingly, new types of sales channels, for example the fund supermarket, will have more influence, and the focus on investors in the discretionary investment market (pensions and other retail investment products) is forecast to strengthen.
E. Emergence of an Asia-based top-tier asset manager
As pension funds and retail clients increase their overseas investments and the discussions for a regional platform progresses, Korean asset managers are predicted to expand their presence in Asia. More and more of them will go overseas through M&A or joint partnerships with local asset managers. Thanks to policy support given to asset managers who want to advance to specific target markets in Asia, we can anticipate the emergence of a top-tier asset manager covering the Asian region.