Unprecedented Change Investment opportunities in an ageing world Baring Asset Management Limited 155 Bishopsgate London EC2M 2XY Tel: +44 (0)20 7628 6000 Fax: +44 (0)20 7638 7928 www.barings.com JUNE 2010 FOR PROFESSIONAL ADVISERS ONLY
Unprecedented Change Investment opportunities in an ageing world The pace of population ageing in the world is unprecedented. The United Nations Population Division estimate that, by 2047, the number of older people in the world will exceed the young for the first time. For these purposes, older includes those aged 60 or more, and the young are those under 15 years of age. By 1998, this historic reversal had already taken place in the developed world. The Potential Support Ratio - the number of persons of working age for each person aged 65 years or older - fell from 12 to 9 between 1950 and 2000, and is forecast to decline to just 4 by 2050. This has important implications for economic growth and for the affordability of social security schemes in Japan and much of Europe, which are most affected. The US, UK, Australia, Canada and Scandinavia have stronger demographics although current arrangements for healthcare provision may need to be reviewed. From an investment perspective, these developments have important consequences for economic growth, savings, investment and consumption, labour markets, pensions and taxation. They influence the way we view the long-term prospects for a number of industries and market sectors around the world, including consumer goods, healthcare and financials. Above all, we believe they underscore the long-term attractions of many of the world's emerging markets, in their own right and relative to their developed peers, from a fixed and an equity perspective. Baring Asset Management, London June 2010 In the developing world, India, the MENA region and Indonesia are likely to enjoy a "demographic dividend" from growing working age populations at least until the 2030s. China, Russia and South Africa are exceptions however, with demographic patterns which are closer to developed economies. Population ageing is being accompanied by urbanisation. The United Nations expects the level of urbanisation to continue rising over the next 40 years, often at the expense of the rural areas and particularly in the world's developing countries. China is undergoing a major transformation of its urban structure. 1
An ageing population Population ageing has been an area of focus for the United Nations since publishing a major report on the topic in 1956. In the past twenty-five years, the UN has organised three major international conferences on the topic, and published a number of detailed research reports. The most important of these for investors today, are the report on "World Population Ageing: 1950-2050", prepared for the 2002 World Assembly on Ageing, and its follow-up, "World Population Ageing 2007". The conclusions from the UN's research are clear. First, as a result of the transition from high to low fertility and the continuous reduction of adult mortality, the population of most countries is ageing, and doing so at an unprecedented pace. A population ages when increases in the proportion of older persons (60 years or older) are accompanied by reductions in the proportions of working age persons (age 15-59). The number of older persons passed the number of children in the developed world in 1998, and the UN forecast that this will happen for the world population by 2047. Proportion of population 60 years or over: world, 1950-2050 (%) 25 22 20 Implications for developed economies The Potential Support Ratio indicates how many potential workers there are for each older person. As a population ages, the Potential Support Ratio tends to fall. Between 1950 and 2007, the Potential Support Ratio declined from 12 to 9 potential workers per person aged 65 or over. The UN predict that the Potential Support Ratio will drop further to reach 4 globally. Of the developed countries, Japan and much of Western Europe face serious issues. Japan already has the world's oldest median age of 43 years. Both Japan and Western Europe have well developed and comprehensive social security systems to support workers once they retire. However, this depends on having a suitable number of taxpayers supporting it. As the Potential Support Ratio declines, both Japan and Western Europe will need to review these systems and decide whether they are affordable. With the decline in the working population, income from tax is likely to come under pressure, everything else being equal. It seems likely that these countries will see their sovereign credit ratings under threat. The US, the UK, Australia, Canada and Scandinavia have stronger demographics. However, the affordability of ageing and healthcare spending is still likely to be a substantial challenge for the authorities, particularly in the US. 15 10 5 0 11 8 1950 2007 2050 Year This has important implications for the affordability of social security schemes. An ageing population will have an impact on the pace of economic growth, long-term savings and investment, consumption, labour markets and taxation. From a social perspective, population ageing influences family living arrangements, demand for housing and the need for healthcare amongst other things. Source: United Nations, "World Population Ageing 2007". 7 1.2 Secondly, this is happening everywhere. However, there are significant differences between developed and developing regions. In the developed regions, over 20% of the population is currently aged 60 years or over. By 2050, the UN predict that this will reach a third of the population. 6 5 4 3 2 1 0.8 0.4 0.0 In the developing regions, older persons currently account for just 8% of the population. The UN predict that this will rise to 20% of the population by 2050: in other words, the emerging 0-1 1955 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010 2015 2020 2025 2030-0.4 world will be where the developed world is now. Euro area population grow th (RHS) Euro area GDP grow th (5 yr m avg. LHS) Source: UBS, Baring Asset Management 2003 2
Banking the demographic dividend Although the world population is ageing, this process is far more advanced in the developed world. Many of the world's developing markets still have favourable demographics - young, growing working age populations ready to enter the workplace. The research carried out by the United Nations suggests that these countries are positioned to enjoy a "demographic dividend" from now until about 2030-2035, where economic growth and productivity should receive a boost from an influx of new workers. Favourable demographics alone are no guide to the countries most likely to realise this benefit. They can be supportive, but political stability and the availability of jobs for these new workers are essential ingredients too if the opportunity is not to be lost. In our view, India, the Middle East and North Africa (MENA), Indonesia and Malaysia are particularly favourably positioned to benefit from demographics over the coming decades. All of these countries have young populations ready to join the labour market. As can be seen below, the contrast between the breakdown of the population of the Arab World and Europe in 2010 is already very marked, and we believe the differential will increase from here. Population by age, years, % of total, 2010 forecast 80+ 70-79 60-69 50-59 40-49 30-39 20-29 10-19 0-9 -25-20 -15-10 -5 0 5 10 15 20 25 Arab World Europe Source: The Economist, 25 July 2009 The exceptions: China and South Africa While many developing countries should benefit from the demographic dividend, China and South Africa are exceptions. Both countries have demographic profiles which are closer to developed markets than developing. As the two charts below show, we expect growth in the labour force to start to stall, and even shrink in the case of China, over the coming years. 4.0 3.0 2.0 1.0 0.0-1.0 1951 1951 1969 1969 1978 1978 1987 1987 1996 1996 2005 South Africa 3.5 3.0 2.5 2.0 1.5 1.0 0.5 0.0-0.5-1.0-1.5 China Source: UBS Investment Bank, 9 September 2008 This is not to say that we do not believe the long-term prospects for these markets are attractive. We remain very positive on the long-term outlook for China in particular. However, we do not expect China or South Africa to receive support from a youthful demographic in the way that a number of other developing economies are likely to over the coming years. In the case of China, wages are clearly already starting to come under pressure. City workers - urbanisation Where we do expect the Chinese economy to find a degree of support, however, is from continued urbanisation. In the "2009 Revision of World Urbanisation Prospects", the United Nations expect urbanisation to continue rising across the world over the next 40 years, often at the expense of rural areas. 2005 2014 2014 2023 2023 2032 2032 2041 2041 2050 2050 3
Once again, this is likely to play out across developed as well as developing economies, although at a slower pace. The pace of urbanisation is likely to be most rapid in the developing world however, and particularly in China, bringing both potential for productivity gains and challenges to provide suitable infrastructure and to tackle rural depopulation. Since the mid 90s, the number of cities in China with at least a million inhabitants has increased markedly. In 1980, China had only 51 cities of that size. This has risen to 235 today, and is forecast to rise to 369 by 2025. China's urban population has more than doubled over the last 30 years and is expected to reach 59% by 2025. UN Urbanisation Projections: China and the World Hypothetical Sovereign Ratings Based on General Government Balance Performance AAA AA+ AA AA- A+ A A- BBB+ BBB+ BBB- Speculative 2005 2010 2015 2020 2025 2030 2035 Germany France UK US 100 (%) Source: Standard and Poor s, 18 March 2005 75 50 25 0 1950 1970 1980 World China Western Europe 1990 2000 2010 2020 Developing Japan USA Source: UN World Urbanisation Prospects, 2007 Revision Database, March, 2010 The investment consequences From an investment perspective, these developments have important consequences for growth, savings, investment and 2030 consumption, labour markets, pensions and taxation. 2040 It is clear that Japan and much of developed Europe face a serious challenge if they are to maintain the current social security system for retirees. It is not clear whether there is the political will to make the changes needed to fund them. It seems likely to us that the credit agencies will downgrade sovereign debt as a consequence. Indeed, in 2005 Standard and Poor s published a paper in which they projected likely sovereign trends based on no changes to government fiscal policies with regard to age-related spending. The results were shocking insofar as they projected the collapse to junk ratings for each of the United States, the United Kingdom, Germany and France by 2035. 2050 The credit crunch has worsened meaningfully the projected fiscal challenge that already faced developed markets seeking medium-term fiscal sustainability. Indeed, it is increasingly looking as though rather than heralding the end of capitalism, the credit crunch may have heralded the end of the welfare state as the provision of age-related services proves too much of a challenge to debt-stricken governments. Governments facing the social, political and economic upheaval associated with a retreat from the provision of cradle-to-grave services may be tempted to inflate their way out of their debt problems. Few governments have the ability to do this decisively. Eurozone governments are at present institutionally constrained by the independence of an inflation-targeting ECB; the United Kingdom by the indexation of large-scale public sector occupational pension obligations; the United States by the short duration of the outstanding stock of debt. Japan could inflate away its debt burden, but has hitherto chosen not to take this route, in part it could be inferred because of the shock it would cause to the domestic holders of Japanese government bonds who are themselves the large cohorts of retirees. To put it bluntly, fiscal sustainability in the developed markets appears possible but implausible, and the implications of this statement are profound from a social, political, economic, as well as investment perspective. 4
There has been some progress, but policymakers have so far chosen to put off the difficult choices that may lead to radically different end-states for each developed economy. Furthermore, it is generally the case that the longer policymakers procrastinate, the larger the challenge that they pass to their successors becomes, and the more extreme the investment implications. Rather than call the turn in, and the course of, policy capitulation in the face of the unsustainable, it is probably worth only to note that liability-driven investment strategies generally rest upon the notion that long-dated government bonds are a duration-matching risk-free asset and this notion may be challenged by policy developments. For a pension fund looking to reduce the volatility of their investment portfolio as their scheme demographic matures, we would favour a volatility-controlled dynamic multi-asset approach that has some potential to navigate the pitfalls of structural policy changes that will necessarily present themselves over the coming decades. In contrast to this rather guarded view as to the opportunities presented by long-dated developed market government bond markets, and domestic demand in the West, we see plenty of demand growth coming from select Emerging Markets. % share global consumption 2007E 2008F 2009F 2010F 2015F 2020F US 30.2 29.3 28.3 27.4 23.5 20.8 Japan 8.2 7.9 7.7 7.4 6.5 5.8 Germany 5.6 5.5 5.3 5.1 4.3 3.8 China 5.3 6.4 8.0 9.3 16.4 21.1 UK 5.0 4.9 4.8 4.6 4.0 3.7 France 4.2 4.1 3.9 3.8 3.2 2.9 Italy 3.6 3.4 3.3 3.2 2.7 2.3 Spain 2.4 2.3 2.2 2.2 1.9 1.8 Canada 2.3 2.3 2.2 2.1 1.9 1.7 India 2.0 2.2 2.4 2.6 3.9 5.3 NE4 * 2.9 3.0 3.0 3.0 3.1 3.1 ASEAN4 ** 1.8 2.0 2.1 2.1 2.5 2.7 Non-Japan Asia 12.1 13.6 15.5 17.1 25.8 32.3 Sources: CEIC, IMF, Credit Suisse estimates. * includes Hong Kong, Korea, Taiwan and Singapore. **Includes Indonesia, Malaysia, the Philippines and Thailand. September 2009 The research conducted by the United Nations also influences the way that we view the long-term prospects for a number of industries and market sectors around the world. In the case of consumer goods, we see excellent long-term potential in China, India and in the MENA region, as a youthful, urban labour force finds new opportunities to spend money. The table below shows the rapid growth expected in Chinese and Indian consumption. One way we are participating in this trend has been to invest in global multi-national companies active in these markets in the multi-asset portfolios we manage. Many of the world's developing countries are net savers, and there is room for growth in financial services too. This is another area we are looking at. Finally, an ageing population has an increased need for good healthcare, and long-term demographics is one of the factors we look at here too when analysing the competitive landscape for companies at Barings. Above all, the work done on emerging demographics underscores our deeply-held belief in the long-term attractiveness of many of the world's emerging markets, both in their own right and relative to their developed and slower-growing counterparts. We have long had a bias to the world's developing equity markets. However, we believe that favourable demographics strengthen the case for investing in the world's emerging debt markets too. The fundamentals for many of the world s developing countries look attractive, particularly when compared to the deteriorating public finances across many developed countries at present. With the prospect of faster growth and improved productivity over the coming decades, we expect the risk premium applied to emerging market debt to come down as the benefits start to come through. With local currencies additionally likely to strengthen against developed market counterparts, we believe the long-term investment prospects for local currency emerging market debt look attractive from here. Baring Asset Management, 9th June 2010. 5
IMPORTANT INFORMATION For Professional Investors/Advisers only. This document is approved and issued by Baring Asset Management Limited and in jurisdictions other than the UK it is provided by the appropriate Baring Asset Management company/affiliate whose name(s) and contact details are specified herein. The information in this document does not constitute investment, tax, legal or other advice or recommendation. It is not an invitation to subscribe and is for information only. The value of any investments and any income generated may go down as well as up and is not guaranteed. Past performance is not a guide to future performance. Quoted yields are not guaranteed. Changes in rates of exchange may have an adverse effect on the value, price or income of an investment. There are additional risks associated with investments (made directly or through investment vehicles which invest) in emerging or developing markets. Investments in higher yielding bonds issued by borrowers with lower credit ratings may result in a greater risk of default and have a negative impact on income and capital value. Income payments may constitute a return of capital in whole or in part. Income may be achieved by foregoing future capital growth. We reasonably believe that the information contained herein from 3rd party sources, as quoted, is accurate as at the date of publication. The information and any opinions expressed herein may change at any time. Companies and employees of the Baring Asset Management group may hold positions in the investment(s) concerned. This document may include internal portfolio construction guidelines. As guidelines the fund is not required to and may not always be within these limits. These guidelines are subject to change without prior notice and are provided for information purposes only. This document must not be used, or relied on, for purposes of any investment decisions. Before investing in any product, we recommend that appropriate financial advice should be sought and all relevant documents relating to the product, such as reports and accounts and prospectus,( which specify the particular risks associated with a product, together with any specific restrictions applying and the basis of dealing) should be read. Compensation arrangements under the Financial Services and Markets Act 2000 of the United Kingdom will not be available in respect to any Offshore Fund. Research Material Baring Asset Management only produces research for its own internal use. Where details of research are provided in this document it is provided as an example of research undertaken by Baring Asset Management and must not be used, or relied upon, for the purposes of any investment decisions. The information and opinions expressed herein may change at anytime. Version 03/2009 Baring Asset Management Limited Authorised and Regulated by the Financial Services Authority 155 Bishopsgate, London, EC2M 3XY Complied (London): 18 th June 2010