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In a lively presentation to delegates at the recent Sanlam Investments Institutional Insights conference in Johannesburg, Dr Amlan Roy, Head of Global Demographics and Pension Research at the investment banking division of Credit Suisse in London, took an in-depth look at demographics and how it impacted the investment strategies of retirement funds.

Roy said demographics played a crucial role in global macro-economics in its entirety – across inflation, GDP growth, debt, asset prices and pensions – because demographics was all about consumers and workers, not just people count, age or mortality. “Consumers consume as much as two-thirds of GDP in most countries, while workers make up the actual GDP,” said Roy. So on both a micro and macro level, demographics affects a multitude of valuation metrics as well as GDP drivers, including assets, liabilities, inflation and macro-policy.

At the recent Sanlam Investments Institutional Insights conference in Johannesburg, Dr Amlan Roy, Head of Global Demographics and Pension Research at Credit Suisse in London, took an in-depth look at the impact of demographics on the investment strategies of retirement funds.

“Correlation does not always equal causation”

Roy stressed that demographics was not a simple matter of lumping people of similar ages into boxes when their spending and saving habits might be fundamentally different. Instead, we should look at demographics in terms of spending patterns -- identifying the consumption habits of different groups and how they combine to contribute to a country’s GDP.

He said a proper understanding of demographic changes was essential to being able to sustain the promises a fund makes to its members.

“We are all consumers and workers, and we all carry potential revenue and costs, no matter what our age,” said Roy. Given this, everyone involved in the process of investment and benefits management should focus on key areas that are driven by changing demographics.

“One has to look at the growth or decline in working-age participation rates, for instance, before gaining a proper understanding of a pension fund’s replacement requirements,” said Roy. “Rising youth unemployment is the single biggest threat to growth and stability in the world today.”

Similarly, institutional investors should not be tempted to generalise across what has become commonly known as the BRICS countries (Brazil, Russia, India, China and South Africa). “One cannot compare fertility, old-age dependency ratios, GDP per capita and life expectancy across so many diverse emerging market regions; they are all too complex with many intricacies and differences.”

New solutions require a multi-pronged approach

Roy identified six investment categories that were most affected by demographic shifts: pharmaceuticals and biotech; financial services; leisure and luxury; infrastructure; natural resources; and emerging markets. To service a growing middle class with a rapidly rising proportion of younger consumers required a different mindset to that in a society where deaths outnumbered births and older dependent people lived even longer, he said.

Such observations prompted Roy in 2000 to publish the Credit Suisse Demographic Manifesto. Its main tenets were: to abolish mandatory retirement ages in favour of more flexible “enabled retirement” options; to increase female participation in the labour pool in order to balance work-family priorities; and for governments to tailor their immigration policies in order to attract the right skills. Consequently, labour, education, health and social-benefits policies had to be reassessed and new solutions devised.

Roy said newer “hybrid solutions” were required by the financial services industry to match a consumer’s expectations with the right product or investment strategy. “You cannot sell the same solution to a 65-year-old and an 80-year-old, despite them being in the same supposed demographic group,” he said. “We have to reassess our frameworks and assumptions.”

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An integrated approach to asset allocation and risk management

By the same token, we need to look at asset allocation and risk management in a much more integrated fashion. Assets should be linked to liabilities, liabilities should be linked to assets and the underlying factors making up asset allocation should also be correlated.

Said Roy, we need to think about assets and liabilities as the 2 “R”s of finance: risk and returns. In a sense, risk management has become like liability management for pension funds. We need to be more sophisticated in our approach to risk management so that we can leverage options or other clever strategies to limit our losses. But at the same time, proper asset management requires both active as well as passive management, and an openness to alternative trends, be they investing in an Africa fund, infrastructure or private equity. But most of all, we should embrace multi-asset class strategies on the asset front and on the liability front, we need better liability longevity models which are calibrated – not once every 5 years – but once every 6 months, because we have the technology, we have the quantitative expertise and we have a richness of data at our disposal to arrive at better retirement promises for our fund members who are going to retire.

Roy said traditional methods of asset allocation between bonds, equities​ and cash had been radically revised during this decade’s market upheaval. He suggested more sophisticated solutions were needed to help a pension fund avoid under-funding and to more accurately match its liabilities with its market value.

Finally, Roy concluded with a key, bottom line message: “Demographics is about consumers and workers, not just people count and age. We need to look more broadly than longevity and mortality. It affects assets, liabilities, inflation and macro-policy”.

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