CHANGES ON THE INSTITUTIONAL INVESTMENT HORIZON:

Transcription

1 CHANGES ON THE INSTITUTIONAL INVESTMENT HORIZON: Asia-Pacific investors seek balance between risk and responsibility Picture credit: Eastimages/Shutterstock.com. China National Olympic Stadium, AKA the Bird s Nest, Beijing, China. Sponsored by:

2 Contents Introduction 1 About the research 2 Key takeaways 3 1 Near and far horizons 4 The effect of the hunt for yield 4 Eyes still on the long-term prize 5 Reputation and responsibility 6 2 Managing risks and changing styles 8 Passive money and the curse of correlation 8 Daring to find difference 9 Looking to new products, new markets 10 Boxout: Rolling with regulation 12 3 Seeking a sustainable future 13 A rising tide 13 Navigating a new world of esg investment 14 Appendix 15

3 Introduction Investors are confronted with difficult decisions and adverse circumstances as a matter of course. But in the current environment, Asia-Pacific institutional investors seem deserving of particular sympathy. Like their peers elsewhere, they are struggling to balance long-term liabilities with the need to secure yield in a world where it is increasingly scarce, which almost inevitably opens the door to greater volatility and risks. And as elsewhere, the rising tide of local and global regulation, coupled with the increasing prevalence of sustainability mandates and environmental, social and governance (ESG) targets, is piling complexity onto this process. But Asian institutional investors are also contending with unique challenges. Their home region is the world s fastest-growing, presenting no shortage of opportunities but also no shortage of risks that could cloud a long-term investment approach from China s growing debt burden to competing territorial claims in the South China Sea and an increasingly bellicose North Korea. Many of the region s largest economies, including China, South Korea and Japan, are aging rapidly, threatening the future viability of pension systems and putting additional pressure on pension funds and insurers to boost returns. In China, for example, the working-age population is forecast to fall by nearly one-quarter by Climate change is also forecast to hit Asia particularly hard, with the Asian Development Bank recently warning of potentially severe impacts on economies, infrastructure and agriculture. Of the 20 major cities set to bear the brunt of global flood-related losses, expected to reach US$52bn annually by 2050, 13 are in Asia. 1 All this leaves Asia s institutional investors with the unenviable task of reconciling competing and sometimes contradictory objectives, simultaneously factoring in current trends and long-term possibilities, all while being subject to the scrutiny of regulators, stakeholders and, in many cases, the general public. How Asian investors approach this delicate juggling act, and how it is shaping their future strategies, is the subject of this paper. 1

4 About the research In June-July 2017, the EIU surveyed 571 institutional investors around the world. The research, which is a part of the Changes on the institutional investment horizon programme sponsored by Franklin Templeton Investments, explored how investors around the world are adapting to changing fundamentals and risks, the effect on the investment time horizons and asset allocations, and the impact on long-term objectives. In Asia-Pacific, the survey included 200 respondents. Of these institutional investors, 56 are from commercial banks, 52 from insurance companies, 41 from pension funds, 30 from endowment funds, and 21 from corporate treasury funds. 73 are large, in that their assets under management (AUM) exceed US$5bn. The remaining 127 investors have AUM of between $1bn - $5bn. Among the respondents, 96 are c-suite executives, and the remaining 104 are nonc-suite Senior executives. We would like to thank the following individuals who lent their time and perspectives in interviews. They are in order of their surnames: Paul Carrett, CIO, FWD Insurance Liu Chunyen, group CIO, AIA Paul Ewing-Chow, associate director, Public Affairs, Temasek Boris Moutier, regional CIO, AXA Asia John Woods, CIO, Asia-Pacific, Credit Suisse Heman Wong, former executive director, Hospital Authority Provident Fund Scheme 2

5 Key takeaways In Asia-Pacific, a prolonged low-yield environment and evolving regulatory landscape have prompted many institutional investors to take more short-term actions in a hunt for yield. Thirty percent of those surveyed say they are more actively managing their investments, 45% say they have reallocated asset classes due to regulations, and 52% are increasing portfolio turnover despite increased riskiness. However, the short-term search for higher returns stands in seeming contradiction to Asia-Pacific investors approach towards their return targets in the current investment environment. Only 26% say immediate pressures have prompted them to adopt a short-term approach to setting return targets, while 39% say these pressures have actually made them more focused on long-term objectives. This places many Asia-Pacific institutional investors in a delicate balancing act between strategizing for long-term growth and trying to capture returns that come into the market on a short-term basis. Asia-Pacific investors see market volatility as the number one barrier to lengthening their investment horizon; other top five reasons include reputational risk, short-term requirements, the global economic outlook and regulatory change. As a result of these fears, in portfolio monitoring 28% of respondents say they are more focused on their fiduciary obligations and 27% say they are more focused on their principles and social/ objectives before prioritizing long-term performance. This also highlights the reality that many regional investors, particularly sovereign wealth and pension funds, have explicit political and social benchmarks along with long-term performance goals. In managing their risks, Asia-Pacific investors are particularly concerned with non-financial (for example, geopolitical) risks and correlation risks, which are leading them to seek diversification across international markets, particularly those in their own backyard. Being already well-versed in their region, 56% of Asia-Pacific investors say they are more likely to increase portfolio allocations to high-growth Asian markets such as China and India. A smaller percentage, 32%, say they are planning to diversify outside the region to manage risks. Asia-Pacific investors are also increasingly seeking alpha and diversification benefits in alternative assets and new products. For 42% of respondents, the increasing use of alternative investments such as private equity, private debt, commodities and real estate is one of the top two ways to manage risk, second only to risk budgeting. Others are exploring diverse, uncorrelated assets from infrastructure to forestry. More use is also being made of derivative products as a means to both hedge risks and enhance yield. Focus on environmental, social and governance (ESG) investment principles or targets is a rising regional trend. Almost two-thirds of investors polled (62%) expect to increase exposure to ESG or principle-based investments over the next three years, and 22% expect to boost exposure in the next 12 months. 3

6

7 1 Near and far horizons The effect of the hunt for yield 2%. Anybody who wants 15% now will have to go With interest rates and yields on institutional to a casino. investment mainstays, particularly developed- Asian institutional investors aren t heading for market government bonds, near historic lows, the roulette wheel, but research has shown they many investors have been forced to adjust their have tended to adopt a shorter-term outlook and strategies and look farther afield to eke out returns adjust portfolios more frequently than those in often taking on more risks in the process. The other regions. Our survey indicates the search for Organisation for Economic Co-operation and yield is likely to exacerbate this tendency. Development (OECD) has warned of an A majority (52%) of Asia-Pacific respondents excessive hunt for yield heightening insolvency say they are taking more short-term actions such risks for pension funds and life insurers as they as increasing portfolio turnover to find yield, struggle to meet the commitments made to despite the increased risk such actions entail. beneficiaries or policyholders when financial Nearly one-quarter (24%) say they are doing so markets were broadly capable of producing frequently, versus 21% in North America and 17% better returns.2 in Europe, the Middle East and Africa (EMEA). A The return target tends to reflect the risk free significant proportion (40%) also say they have rate [RFR], whatever that might be, says John adjusted their average holding periods to be Woods, CIO Asia-Pacific at Credit Suisse. If the much or somewhat shorter in response to low RFR is 5%, then investors tend to want the RFR plus yields, worsening demographics in developed a spread. If the RFR is 0%, then that influences the markets and the pressure to generate alpha, or target. Ten to 15 years ago investors wanted 15%, returns in excess of benchmarks. now they want 3% and they would be happy with Asia-Pacific institutional investors increasing short-term actions % respondents Increasing short-term actions 52 Not taking short-term actions 47 Don't know 1 Asia-Pacific institutional investors adjusting holding periods % respondents Shortened average holding periods Lengthened average holding period Don't know 5 40 Have not adjusted average holding period

8 The need for yield has been a slow burn and In Japan, for example, more than one in four we have seen investors going down the credit people was aged 65 or over in 2015 but by 2036 curve, says Paul Carrett, group CIO at FWD one in three will be. This will challenge pay as you Insurance. so go pension funds that will have to support a rising dramatic, but if you look at it over a longer point number of retirees with contributions from a of view it s been pretty dramatic. And we could shrinking workforce a gap that even the best see a dramatic reaction at some point when we strategies to maximise investment returns will have a crisis. struggle to address. There are currently 2.3 Short-term it doesn t seem working-age Japanese for every retiree, but this will decline to 1.3 by Eyes still on the long-term prize Standing in apparent contradiction to this Not surprisingly, 55% of Japanese survey behaviour is the increasing weight placed on respondents say they have increased their focus long-term goals. Only around one-quarter (26%) on longer-term objectives, the highest rate in the of respondents say immediate pressures have region. The demographic issue is, however, prompted them to adopt a shorter-term approach virtually an Asia-wide one; Hong Kong will shed to setting return targets, and 29% that their process over half a million workers by 2064, and in Thailand for determining return targets has not changed. the working age population s share of the total Furthermore, 39% say these pressures have will shrink by 11% to 2040 the steepest decline in actually made them more focused on long-term developing Asia. objectives. The need, then, to lengthen investment For insurance companies the strategic focus horizons to match lengthening liabilities is vital might be on long-term growth for policyholders and and shareholders, but as Liu Chunyen, group CIO concerns often stand in the way. When asked to at AIA, explains, This is not to say that we don t identify the biggest barrier to this process, the take short-term opportunities to increase yield highest proportion (35%) of Asian institutional We re aiming for long strategy, longer-term investors cite market volatility which is also the top investment horizon, longer-term assets, but we will pick among investors in North America and EMEA. increasingly look at more opportunities that come This may seem counterintuitive with the into the market on a short-term, technical basis. Chicago Board Option Exchange s Volatility Index It is a delicate balancing act. For those with (VIX) a global market volatility benchmark lengthening liabilities, like pension funds, short- plumbing historic lows, but there are ample term volatility or adverse market conditions indications that investors across the world expect highlight the difficulty of achieving future targets, volatility to rise. In Asia, too, there is no shortage of particularly in markets where demographic memories of relatively recent market shocks, from trends could call the very existence of such funds the taper tantrum in 2013 when the US Fed into question. hinted at unwinding quantitative easing, to generally understood, but near-term Asia-Pacific's Ageing Population % of people aged 60 or over 50% 40% % 20% % 0% Australia China Hong Kong Japan Malaysia Singapore Thailand Source: UN World Population Ageing

9 China s dizzying stock market plunge in 2015, to blunting its ability to generate returns. Australian the descent of the Malaysian ringgit in 2017 to superannuation funds and insurers have come lows not seen since the Asian financial crisis. The under fire over potential conflicts of interest and challenge for institutions making for a distant alleged reluctance to pay out claims. In China, shore is to contend with the waves they will regulators have targeted the insurance industry encounter en route. over its allegedly aggressive investment strategy We are fully conscious that with a portfolio and warned of potential reputational damage. largely comprised of listed assets, we are not Similarly, in portfolio monitoring, Asian investors immune to short-term market volatility, Paul seem more focused on their fiduciary obligations Ewing-Chow, associate director for public affairs and at Temasek, Singapore s S$275bn (US$200bn) performance. Fiduciary responsibility (28%) and sovereign wealth fund, wrote in an interview. principles/social objectives (27%) are the top two That said, [G]iven we own our assets as opposed factors driving portfolio monitoring in the survey, to being a fund manager on behalf of the followed by long-term performance. This is similar government we don t have redemption to the breakdown in EMEA but not North America, obligations, and have full flexibility to buy, sell or where long-term performance comes marginally hold assets over longer-term horizons, to deliver ahead of principles and social objectives. returns over our risk-adjusted cost of capital. social benchmarks than long-term This highlights the reality that many regional investors, particularly sovereign wealth and Reputation and responsibility pension funds, have explicit political or societal Asia-Pacific investors also identify reputational in addition to long-term investment goals. China risk as the second biggest impediment to Investment Corporation s main pledges, for extending their investment horizon, picked by 29% example, include preserv[ing] and increas[ing] of those surveyed. This compares to 26% in EMEA the value of state-owned financial assets,3 while and just 20% in North America, indicating Asian Khazanah Nasional, the Malaysian government s fiduciaries may be more sensitive to government sovereign wealth fund, plays a catalytic role in or driving various strategic industries and national public opprobrium for performance or initiatives.4 administrative lapses. This sensitivity may exist for good reason, as Along with short-term market developments, there are multiple recent, relatively high-profile these principles have the potential to complicate examples of institutional investors coming under the formulation of long-term investment strategies. the microscope. In South Korea, insiders at the And achieving social mandates is unlikely to massive National Pension Service, the world s absolve institutions of the need to boost returns to third-largest pension fund with US$497bn of assets meet future obligations, underlining again the under management (AUM), have pointed to web of interests investors must navigate as they parliamentary audits and political interference make decisions and manage portfolios. Barriers to longer investment horizons % respondents, with two choices Market volatility 35 Reputational risk 29 Short-term requirements 27 Global economic outlook 27 Regulatory change 23 Lack of staff incentives 17 Governance rules 15 Media influence on decision makers 15 Silos within the organisation 14 7

10 Pension funds need to think more from the This is particularly something that needs to be angle of the beneficiaries, says Heman Wong, addressed in Asia where some of the pension former executive director at Hospital Authority funds have grown very big too quickly. There is a Provident Fund Scheme in Hong Kong. They big knowledge gap as the region does not yet need to be careful that they don t do only what have enough investment professionals. they are supposed to if members are unhappy, this can be very damaging. Portfolio monitoring drivers % respondents Fiduciary responsibility 28 Short-term performance 17 Long-term performance 21 Principles / social objectives 27 Reputational risk

11 2 Managing risks and changing styles As investors juggle at times competing goals and Risk concerns in Asia also have a more adjust portfolios or styles more frequently, the risk pronounced picture has changed significantly for many. No potential flashpoints such as the Korean Peninsula longer can institutions simply park most of their and the South China Sea, and trade-related and funds in relatively stable government bonds and other warnings directed at countries like China expect solid returns to meet their liabilities from the Trump administration. Non-financial (for decades ahead; portfolios are now more typically example, geopolitical) risks are cited as one of spread across a broader range of assets that the top two biggest risks to achieving long-term carry various risk exposures and duration profiles. investment targets, selected by 47% of Asian This has increased worries about risk and investors. This view is shared in EMEA but not in redoubled North America, where institutional investors are the industry s emphasis on risk management. geopolitical dimension given more concerned about short-term volatility and In the Asia-Pacific region, financial stability risks liquidity. and the economic cycle are the main worries of institutional investors, picked as the top two Passive money and the curse of correlation concerns by 43% and 40% of survey respondents Asia-Pacific and EMEA investors also agree that respectively. This again points to heightened correlation risk is the other main threat, with 50% awareness of the possibility of short-term market and 58% respectively placing it in the top two risks developments such as another sudden currency to long-term investment goals, versus just 40% in devaluation in China, or a dip back into deflation North America. In essence, this is the fear that due in Japan derailing strategies and long-term to close correlation between the various assets in investment goals formulated for times of relative a portfolio, adverse events can cause significant stability. losses across all of them. Current concerns of institutional investors % respondents, with two choices Financial stability risks 43 The economic cycle 40 Mispricing of risk 30 Market volatility 27 Portfolio diversification 21 Geopolitical uncertainty 17 Corporate governance 15 Inflation 8 9

12 Diversification that is seeking assets that are not correlated (or are negatively correlated) so that a single event or trend doesn t devastate the whole basket reduces portfolio risk. But diversification has become more elusive. The globalisation of financial markets, an extended period of massive liquidity from central banks, and the hunt for yield have resulted in a flood of cash into a wide range of assets, breaking down traditional correlation patterns. Even stocks and bonds, which historically tended to move in opposite directions, have more recently been moving in tandem. The exponential growth of passive funds, particularly in the US, where passive investments are expected to account for over half of assets under management in the next four to seven years, has been blamed for exacerbating correlation and further challenging diversification. If you look at it from the perspective of longterm investors such as ourselves, we do worry at a systematic level and whether there are enough people making an active decision about what the value of a company is, says Mr Carrett. Investors disagree and they argue; capitalism can be messy and it s not perfect but that s what makes the market when you have buyers and sellers. If you don t have enough people deciding the value of a company, at a fundamental level things can be mispriced for a longer period of time. You can have a sheer wall of money pushing a stock price in one direction, and that means as an active investor you have to hold your position for longer. The end result is that effective risk mitigation and portfolio management are far more difficult. Diversification is no longer what it used to be, and the traditional stock-bond mix may no longer be enough to create a truly diversified portfolio. This has prompted institutional investors to explore farther and at times riskier territory. Daring to find difference With true diversification increasingly found only beyond standard stock and bond markets, Asian institutional investors have more appetite for alternative assets that have more potential to reduce portfolio correlation and generate the higher returns needed to meet long-term targets. A 2016 report from consultancy Cerulli Associates noted a decline in the number of traditional investment mandates issued by Asian institutions, while demand for alternative investment strategies had increased markedly, particularly in China, South Korea and Hong Kong. Some South Korean institutions, the report noted, are targeting to invest at least 20% of their portfolios in alternatives before In our survey, 42% of Asian respondents name increasing use of alternative investments such as private equity, private debt, commodities and real estate as one of the top two ways to manage risk, second only to risk budgeting (46%). More institutions are investing directly in private firms. Singapore s GIC, for example, has snapped up stakes in an unlisted Philippines food producer and a Brazilian online sports retailer; along with Temasek and Malaysia s Khazanah, it is among the largest global sovereign fund investors in the tech sector. Others, alone or as part of consortia, are exploring diverse, uncorrelated assets from infrastructure to forestry. Even Japan s famously conservative Government Pension Investment Fund (GPIF) is getting in on the act; it is aiming to invest up to 5% of its portfolio in alternatives and recently put out a call for private equity, infrastructure and real estate investment managers. Investors interviewed for this paper are also steadily exploring new products and asset classes that are gaining traction in the region. If you look at the banks, they have been deleveraging their portfolios, says Mr Carrett of FWD. Especially in Europe, banks have been implicitly selling portfolios of private loans to investors like us and that s somewhere where we can get involved. And of course we do have private equity, but with so much money going into it the broader market will struggle, so you have to spend more time picking the right managers and opportunities. Certainly, investments like these suit a longer investment horizon and a willingness to tolerate greater liquidity risk. Though for institutional investors there is a reduced need for immediate liquidity, they still need to be compensated for committing assets over the long-term, Mr Woods says. In private equity investors are more willing to be locked up for four to five years, but they need to be compensated for this by returns. No investor is willing to be locked up for five years for a 3% return. The drive for diversification, as well as concerns about correlation, financial and political risks, may be behind an Asian institutions apparent aversion to passive investment. Just 27% of those 10

13 Managing portfolio risks % respondents, with two choices Risk budgeting 46 Increasing use of alternative investments 42 Currency hedging 40 Diversification of traditional asset classes 33 Hedging with options 30 Volatility hedging 11 polled in Asia-Pacific said they adopted a mostly In terms of diversification, for Asian entities the or entirely passive investment approach, versus first action is typically to go offshore to the extent 30% in EMEA and 52% in North America. that regulations allow, says Boris Moutier, regional CIO at insurer AXA Asia. For many Asia-based investors, the Asian market is a natural first step for Looking to new products, new markets Asian investors also seem to see more diversification. But we believe, especially for fixed diversification opportunities emerging in the income, if you want to access broader investment future. Asked to identify the top opportunities for opportunities, you should go for global emerging alpha creation over the next three to five years, markets beyond Asia. Within our strategic asset the top two responses were the development of allocation, we have diversified the credit bucket new products (48%) and the opening of new with global emerging market bonds, in addition markets (38%). The latter was perceived as the top to domestic Asian corporate bonds. opportunity in North America and EMEA as well, Another difference is that in Asia there is more selected by 52% and 54% of investors in in the two room regions respectively. particularly in closed markets such as China. Due growth in investment products, This likely reflects a couple of key regional to a combination of market forces and regulatory differences: one is that Asia-Pacific investors are reluctance many products active and passive more comfortable at home while investors have been slow to gain traction in the region. By elsewhere may still see Asia as a largely untapped mid-2015 Asia accounted for less than 8% of market. Asia-Pacific investors seem already well- hedge fund AUM, for example, and leveraged/ versed in their own backyard; 56% say they are inverse ETFs were only approved in Hong Kong last more likely to increase portfolio allocations to high- year. No Asian market has yet approved the growth Asian markets such as China and India, distribution of actively managed ETFs. while only 32% say they are planning to diversify outside the region to manage risks. This leaves room to grow, and more use is being made of derivative products as a means both to Opportunities for alpha creation over the next 3-5 years % respondents, with two choices New products 48 New markets 38 Increased focus on factors 36 Regulation arbitrage opportunities 34 New/advanced technology solutions/tools 23 Limited opportunities 10 Don t know 1 11 for

14 hedge risks and enhance yield. Not all markets in Asia are equipped with efficient derivative markets but hedging with derivatives is typically a strategy we use to mitigate volatility, says Mr Moutier. We also use them for yield enhancement to efficiently replicate the returns of a cash asset. For example, credit default swaps are used to gain credit exposure akin to corporate bonds. Mr Carrett of FWD agrees: Derivatives are one area where we can be thoughtful and make money. In the near future, burgeoning demand and the region s continued robust growth will also continue to broaden the pool of products linked to alternative assets. Take infrastructure: the Asian Development Bank estimates Asia s infrastructure needs will reach US$26 trillion through 2030, 6 much of which will be funded through private sources, presenting a significant opportunity to achieve low correlations and long-term returns. Innovations in ESG investment are also emerging in markets like Australia, a leader in green and social debt issuance, to meet rising demand for sustainable assets a phenomenon explored in the next section. 12

15 Rolling with regulation The increasing emphasis on regulation at the typically allocate up to 10% of total expenses global level and the pace of change in the to regulatory compliance and that most region s diverse patchwork of regulatory expect this amount to rise further.7 regimes make it no surprise that regulation is Mispricing of risk is the second most reshaping the investment process. Asian immediate regulation-related concern, institutional investors see regulation having chosen by 48% of respondents. This may the biggest effect on provisions for post- reflect the reality that some of the most trade compliance (selected by 57% as one ambitious regulatory initiatives currently of the top two areas being impacted by emerging globally, such as the European regulation) investor Union s Markets in Financial Instruments protection covering the entire lifecycle of Directive II (MiFID II), will have major products and services (53%). implications for the ways institutions account and provisions for This emphasis is likely to increase further given recent regulatory activity in this area. for and manage risk and for pre and posttrade transparency. Hong Kong, for example, has launched One thing is clear: post-crisis prudential consultations on enhancements to financial rules have increased the focus on the impact dispute will of short-term events on portfolio valuations. significantly boost the ability of investors to Short-termism is largely a reflection of the make claims, while Singapore recently way books are accounted, says Mr Woods strengthened safeguards for retail investors. of Credit Suisse. For many years it was a The resolution biggest practices that short-term headache process regulation for of accrual and books Asian managed over a much longer time horizon. institutional investors is mitigating compliance If you had a bond it was booked at par at the issues, chosen as a concern by 51% of those beginning and at par at the end now there surveyed. This is in line with research showing is much more focus on volatility and the P&L that compliance is demanding a greater because of the requirement to mark-to- portion of institutions financial, technological market. associated with and human resources. A recent study in Japan, for example, showed fund managers Impact of regulatory change % respondents, two choices 13 were Provisions for post trade compliance 57 Provisions for investor protection covering the entire lifecycle of investment products and services 53 Provisions for pre and post trade transparency 50 Provisions for internal risk review 27 Provision of policies to supervise new technology/technological disruptors 13 Don't know 1

16 3 Seeking a sustainable future A rising tide to increase investments of this type. This in line with Institutional investors in Asia have generally been views in North America and EMEA, indicating a seen as lagging those in other regions in terms of degree of convergence in the ESG outlook. adopting ESG investment principles or targets. A The region s largest investors are also leading report by the Global Sustainable Investment the sustainability charge. Japan s GPIF has Alliance found sustainable and responsible established an ESG division, and sustainability is a investments accounted for just 0.8% of managed chief consideration for Singapore s Temasek, assets in Asia in 2016 (excluding Australia and according to Mr Ewing-Chow. Japan), unchanged from 2014 and compared to 52.6% in Europe and 21.6% in the United States.8 Temasek considers environmental, social and governance factors when we make decisions as This looks set to change. The same report found an investor, asset owner and shareholder, he sustainability-themed investments are growing says. We encourage companies, including our across the region at 73% annually, helped by the own portfolio companies, to adopt responsible increasing interest in green finance in its largest and sustainable practices in their businesses, economy, China. Sustainable assets in China operations and supply chains. swelled from US$450m in 2014 to almost US$3bn Mr Woods of Credit Suisse sees the confluence last year as the country pursues a cleaner energy of demand for sustainable investing from multiple policy. stakeholders having an impact. We take social Our survey also points to ESG being a rising impact investing very seriously, partly because regional force. Almost two-thirds of Asian investors investors are demanding it and also because polled (62%) expect to increase exposure to ESG shareholders or principle-based investments over the next demanding it, whether it is embedded as a three years, and 22% expect to boost exposure in requirement or as a specific social impact fund, the next 12 months. Only 12% have no plans at all he says. and activist shareholders are Increasing exposure to ESG or principle-based investments % respondents Yes, increase it in the next 1 to 3 years 41 Yes, increase it in the next 0-12 months 22 Yes, increase it in the next 3 to 5 years 17 No intention to increase level of ESG or principle based investments 12 Yes, increase it in the next 5 to 10 years 9 Don t know 1% 14

17 Navigating a new world of ESG investment While overall trends are positive, there are also indications of duration-related tensions in strategies towards sustainable assets. Among Asian investors polled, 87% say changing demographics are at least to some extent causing them to shorten ESG holding/investment periods; 85% say the same of technological disruption; and 78% the same about climate change concerns. As many sustainable assets for example, clean energy installations, or green buildings and transportation networks are built and designed to deliver over the longer-term, this points to a degree of concern about the ability of these assets to meet long-term goals. Investors may be rightly worried, for example, about demographic decline affecting the financial viability of an environmentally friendly, urban light rail system, while seasonal variations brought about by climate change could threaten the productivity of wind and solar farms. A lack of consensus on what exactly constitutes sustainable investing could also be playing a part. All asset owners I speak to say they are supportive of ESG; the only challenge is the implementation, says Mr Wong. There are some big funds that give specific ESG mandates, but it s not as simple as it looks as everybody uses different measurements. For example, is it good to outsource or bad? If you are outsourcing, is it okay to outsource to Vietnam? China? Russia? However, in the long run, ESG investing should deliver better returns as it won t have a negative impact on your reputation, and if you re following sustainability principles you won t be fined by a government for making an environmentally damaging investment. With demand for sustainable assets on the rise, there has been a wellspring of innovation in sustainability-themed products that will support the sector s further growth while simultaneously addressing various investor needs in terms of time horizons, yield and risk tolerance. Vehicles have emerged to channel funds into everything from clean water to sustainable forests. China has swiftly emerged as the world s biggest green bond market. In Australia, social impact bonds a relatively untested asset class in which the proceeds are used to fund social goals or projects have met with strong appetite from institutional investors. With both regulators and investors pushing for more ESG adoption and disclosure, this field will be even more vibrant in the years ahead. The question is to what extent the region s institutional investors will be able to seize these opportunities while managing their other obligations, as well as the short-term risks and long-term forces likely to put even the most meticulously-planned strategies to the test. As FWD s Mr Carrett says, As investors, we can generate returns by diversifying sources of alpha and making sure bets are not highly correlated. It s not easy but you hope that some of your bets are paying off while others will pay off in the future. 15

18 Appendix: Survey results Percentages may not A. Which of the following best describes your title? add to 100% owing to Please select one. rounding or the ability of Non-c-suite respondents choose 52% to multiple responses. C-suite 48% B. What are your organisation's global assets under management in US dollars? Please select one. $1bn-$5bn 64% $5bn or more 37% 16

19 C. Which of the following most closely describes the organisation that you currently work for? Please select one. Commercial banks 28% Insurance companies 26% Pension fund 21% Endowment fund 15% Corporate treasury fund 11% D. What is your main functional role? Please select one. Investment management 31% General management 21% Business development 21% Finance 15% Strategy 13% Other 1% 17

20 E. To what extent are you responsible for making your company s investments decisions? Please select one. Share responsibility with others 66% Personally responsible 32% Advise, but not personally responsible 3% 1. What do you consider to be the biggest impediment to lengthening the investment horizon? Please select up to two. Market volatility 35% Reputational risk 29% Short term requirements 27% Global economic outlook 27% Regulatory change 23% Lack of staff incentives 17% Governance rules 15% Media influence on decision makers 15% Silos within the organisation 14% 18

21 2. What aspects of the investment process do you believe to be most impacted by regulatory change? Please select up to two. Provisions for post trade compliance 57% Provisions for investor protection covering the entire lifecycle of investment products and services 53% Provisions for pre and post trade transparency 50% Provisions for internal risk review 27% Provision of policies to supervise new technology/technological disruptors 13% Don t know 1% 3. Given the changing global regulatory environment, where do you think opportunities for alpha creation will arise over the next 3-5 years? Please select up to two. The development of new products 48% The opening of new markets 38% Through an increased focus on factors 36% Differentials in regulation across jurisdictions increasing arbitrage opportunities 34% Through new/advanced technology solutions/tools 23% There will be limited opportunity for alpha creation over next 3-5 years 10% Don t know 1% 19

22 4. What are your short-term concerns around regulatory change? Please select up to two. Mitigating compliance issues 51% Mispricing of risk 48% Difficulties in the re-allocation of internal resources 38% Competing objectives 33% Disjointed regulation with material impact on returns 26% None of the above 3% 66% 5. What drives your portfolio monitoring? 32% Please select one. Fiduciary responsibility 28% 2% Principles/social objectives 27% Long-term performance 21% Short-term performance 17% Reputational risk 9% 20

23 6. To what extent have the following trends caused you to shorten your average hold/investment period for ESG investments? - Changing demographics Moderate impact 40% Some impact 32% Significant impact 15% Little impact 10% No impact at all 2% Don t know 2% 7. To what extent have the following trends caused you to shorten your average hold/investment period for ESG investments? - Growing incidence of technological disruption Moderate impact Some impact 39% 36% Little impact 13% Significant impact 10% No impact at all 3% 21

24 8. To what extent have the following trends caused you to shorten your average hold/investment period for ESG investments? - Growing concerns around climate change Some impact 34% Moderate impact 27% Little impact 19% Significant impact 18% No impact at all 3% Don t know 1% 66% 9. Given the changing demographic profile of institutional investors and changing governance 32% rules within institutional investor funds, do you expect to alter your exposure to ESG or principle based investments? Please select one. Yes, increase it in the next 1 to 3 years 41% 2% Yes, increase it in the next 0-12 months 22% Yes, increase it in the next 3 to 5 years 17% No intention to increase level of ESG or principle based investments 12% Yes, increase it in the next 5 to 10 years 9% Don t know 1% 66% 32% 2% 22

25 10. Which information sources do you rely upon most in helping you to develop your asset allocation strategy? Please select two. Company reports and financial statements 57% Direct personal contact (e.g., Investor meetings, roadshows) 57% External advisory services 21% General information (general news media, Website based information) 21% Private online financial communities/groups 19% Colleagues 13% Social media (e.g., Twitter, LinkedIn, Facebook) 8% Other investors 7% 66% 11. What do you consider the biggest risk to achieve long-term targets given longer term trends like 32% climate change and technological disruption? Please select up to two. Correlation risk 2% 50% Non-financial risks (e.g., geo-political risk) 47% Liquidity risk 42% Short-term volatility 41% Capital loss 21% 23

26 12. When it comes to managing risks, how do you do this? Please select up to two. Risk budgeting 46% Increasing use of alternative investments (e.g., private equity, private debt, commodities, and real estate) 42% Currency hedging 40% Diversification of traditional asset classes 33% Hedging with options 30% Volatility hedging 11% 13. What best describes your global equity exposure? Please select one. Split between active and passive 37% Mostly passive 25% Entirely passive 19% Mostly active 11% Entirely active 6% Does not apply 2% Don t know 2% 66% 32% 2% 24

27 14. Given the decline in global fixed income yields and changing governance rules in response to regulatory and technological changes, have you taken on a more active investment approach? Please select one. It is equally split between active and passive 40% No, it is mostly passive 21% Yes, it is now a mostly active approach with some passive elements 16% Yes, it is now an entirely active approach 14% No, it is entirely passive 6% Don t know 4% Does not apply 1% 66% 15. Is the search for yield leading you to take short-term actions such as increasing portfolio 32% turnover despite the increased riskiness of such actions? Please select one. No, not taking any short term actions 47% 2% Yes, sometimes 28% Yes, frequently 24% Don t know 1% 66% 32% 2% 25

28 16. In light of low yields, worsening demographics in the G-7 markets (the US, Canada, France, Germany, Italy, Japan and the United Kingdom) and the need to generate alpha, have you adjusted your average holding period for your portfolio to be shorter or longer? Please select one. No I ve not adjusted my average holding period 42% Yes I ve adjusted my average holding period to be somewhat shorter 31% Yes I ve adjusted my average holding period to be much shorter 9% Yes I ve adjusted my average holding period to be somewhat longer 8% Yes I ve adjusted my average holding period to be much longer 7% Don t know 4% Does not apply 1% 17. Have you changed the process you use to determine your return target in response to short-term pressure? Please select one. Yes, I have become more focused on meeting my longer-term objectives 39% No I have not changed the process to determine my return targets 29% Yes, I have become more short-termist 26% Don t know 5% Doesn t apply 1% 26

29 18. What do you believe to be the main concerns of institutional investors in your region? Please select two. Financial stability risks 43% The economic cycle 40% Mispricing of risk 30% Market volatility 27% Portfolio diversification 21% Geopolitical uncertainty (e.g. North Korea, China/US relations) 17% Corporate governance 15% Inflation 8% 19. Has a change in financial regulations led you to actively reallocate your portfolio away from or towards a particular asset class? No, a change in financial regulations has not led me to reallocate away from or towards a particular asset class 46% Yes, away from a particular asset class 23% Yes, toward a particular asset class 22% Don t know 9% Doesn t apply 1% 66% 32% 2% 27

30 20. Given that the Asia-Pacific region is forecasted to continue to have higher growth rates than EMEA or North America, are you more or less likely to increase your portfolio allocations to the high growth rate countries in your region (e.g., the Philippines, Cambodia, China, India)? More likely 56% Less likely because of the need to manage risk and therefore diversify my portfolio outside the Asia-Pacific region 32% Don t know 13% 66% 21. Which asset types will you look to move into? 32% Equities 2% 50% Bonds and other fixed income 41% Commodities 39% Alternatives (e.g., Private Equity, private debt, real estate) 34% Funds 19% Cash 9% 28

31 22. Given longer-term demographic trends reflected by an aging population in some countries and a growing Islamic population in other countries in the Asia-Pacific region, have you implemented or are you planning to implement principle based investment (e.g., ESG, Sharia compliant investing) into your investment process? Yes, I plan to implement this in the longer-term but do not see it as a strategic issue right now 39% Yes, I already have this as part of my portfolio allocation strategy 36% No, I do not plan to implement this into my portfolio allocation strategy 15% Don t Know 10% Doesn t apply 1% 29

32 LONDON 20 Cabot Square London E14 4QW United Kingdom Tel: (44.20) Fax: (44.20) NEW YORK 750 Third Avenue 5th Floor New York, NY 10017, US Tel: (1.212) Fax: (1.212) HONG KONG 1301 Cityplaza Four 12 Taikoo Wan Road Taikoo Shing Hong Kong Tel: (852) Fax: (852) SINGAPORE 8 Cross Street #23-01 PWC Building Singapore Tel: (65) Fax: (65) singapore@eiu.com GENEVA Rue de l Athénée Geneva Switzerland Tel: (41) Fax: (41) geneva@eiu.com Whilst every effort has been taken to verify the accuracy of this information, neither The Economist Intelligence Unit Ltd. nor the sponsor of this report can accept any responsibility or liability for reliance by any person on this report or any of the information, opinions or conclusions set out in the report.