Following is a translated digest of “Survey of Pension Product Supply and Demand 2020”. The original appeared in AL-IN, a Japanese magazine for institutional investors (vol. 56, July 2020). This is Part 2 of 2.
In Part 2, we look at the market for products offered to domestic pension funds, both in terms of demand by pensions and supply by asset management companies. We sorted 57 products offered to pensions into 3 categories: bond/credit, equity, and others. Respondents were asked whether they have adopted, are considering adopting, or are planning to increase/decrease allocations for each product.
The survey revealed: 1) increased diversification in the fixed income/credit category; 2) more respondents adopting or are considering adopting assets from a wide range of asset classes, including ESG investments and low-liquidity debt products.
Bond & Credit Products
As of the last survey in 2018, domestic and foreign bonds (both actively and passively managed) accounted for a high proportion of the total. However, the June 2020 survey indicates their dominance is waning, as shown in CHART 4. No bond product has seen a significant increase in adoption or consideration, which suggests that funds are flowing to other assets and confirms the decline in the number of pension funds considering bond alternatives, as noted in Part 1.
In this year’s survey, the number of bond and credit products considered for adoption has decreased. In 2018, relatively new products such as unconstrained & multi-credit and smart beta & factor investment funds were considered, and both were the most popular products among bonds and credit-based assets at 11.8%. The percentages for those products slumped to 3.1% and 4.7%, respectively, in the current survey, but not because of a significant increase in adoption.
Among bond and credit assets, convertible bonds (CB) enjoy increasing demand, with 7.0% of pension funds considering them for adoption. Excluding other bond and credit-based products, the percentage of non-CB products under consideration is less than 5% across the board. Following Corona shock, the world is heading toward even lower interest rates. Such an environment makes it difficult for pensions to adopt or consider bonds and credit products.
While there is no particular jump in the number of planned increases compared to the previous survey, the number of products considered for reduction has decreased overall as well.
Among bond and credit assets, passive domestic bond products continue to show a significant downward trend, but the trend has become more gradual (33.0% to 26.1% to 15.6%). This suggests a significant percentage of pensions have reduced their holdings in these products.
On the other hand, hedged foreign bond funds (both actively and passively managed) are most under consideration for an increase (passive10.9%, active 10.2%). It is interesting to note that fewer respondents are planning to reduce the funds than in the previous survey (passive 6.7% to 2.3%, active 11.8% to 3.9%). This may be due in part to the downward trend in hedging costs as the gap between domestic and foreign interest rates has narrowed.
As with bond and credit products, the adoption of equity products -- whether domestic, foreign, passive or active -- declined by 5 to 10 percentage points each. Against this backdrop, there was some increase in the adoption of actively managed global equities, which rose to 23.4% from 21.8% in the previous survey. This may be due to more pension funds leaving the traditional framework and switching to global equities on PAM.
Particularly noteworthy is the growth in ESG investments (including impact investments). The adoption rate for ESG product was only 7.6% in the previous survey, but it more than doubled to 15.6% in the latest survey. This is evidence that ESG investment is gradually penetrating domestic pension funds. ESG investment continues to be the most popular equity-based product considered for adoption, albeit at 15.6%, down slightly from 17.6% in the previous survey. Many pensions listed the promotion of ESG investment as an issue, and that acknowledgment is probably reflected in their product adoption and consideration.
As for planned increases in investment amounts, active products outperform passive products among domestic, foreign, and global investments. In particular, actively managed investment in foreign stocks is the 2nd most popular choice after ESG investment.
Interestingly, the same is true for planned reductions. Actively managed investment in domestic stocks is the only category with a double-digit decrease expected among equity-based products.
The most prominent category is ESG investment, with 23.4% of respondents planning to increase their investment. The figure is higher than in the previous survey, in which 15.1% of respondents planned to increase their ESG investment, the highest among equity-based products as well.
Among bond alternatives, the increasing focus on private assets to obtain yields stands out in the latest survey. Many assets have seen greater adoption, indicating continuous strong need for these other products.
Direct lending, which has a high affinity with bond and credit products, has seen a significant increase in adoption over the past two years, up 6 points to 20.3% from 14.3% in the previous survey. Among real estate-related products, domestic private REITs remain as popular as ever, but adoption has increased for most other products as well. Overseas real estate, in particular, continues the trend that caught attention in 2017-2018.
The adoption rate of open-ended overseas real estate funds grew from 5.0% in 2017 to 10.9% in 2018, to 14.1% in this year's survey, and the rate of funds under consideration went from 6.0% to 9.2% to 8.6%. The adoption rate of closed-ended funds fluctuated from 2.0% to 1.7% to 5.5%, and the rate of those under consideration went from 6.0% to 5.0% to 7.8%. Open-end real estate funds have been the most popular, but closed-ends are getting attention as well.
Infrastructure, a typical low-liquidity asset, has seen a similar increase in the adoption rate. Although there was no significant change between 2017 and 2018 (12.0% to 12.7% adopted, 13.0% to 9.2% under consideration), in the latest survey 19.5% of respondents reported adopting infrastructure-related assets and 10.9% reported such assets under consideration. This shows that adoption has progressed and demand is still there.
The figures for planned increases show increasing demand for low-liquidity assets. In particular, private equity is gaining in popularity, ranking high along with secondaries. Many respondents said they plan to increase their exposure to direct lending and debt products such as real estate debt and infrastructure debt.
Insurance-linked products (e.g., CAT bonds and other non-life insurance products), confronting a series of major natural disasters around the world, are the only other products with more than 10% of respondents planning a reduction. There are few plans to increase these products, and the situation is challenging.
The number of pensions planning to increase their exposure to equity hedge funds fell in the current survey (12.6% to 4.7%), while many investors indicated their intention to increase in the previous survey. Furthermore, few investors plan to increase holdings in other hedge fund-related products. The recent excess liquidity market seems to have contributed to the lackluster performance among hedge funds in general.
On the other hand, many investors still plan to increase multi-asset products (12.6% to 13.3%). Among “other products”, multi-asset strategies and low-liquidity assets will likely continue to be popular.
Lastly, survey respondents were asked what they considered important when considering a product. Available responses were "very", "fairly", "not so much" and "not at all”.
As in previous surveys, the factors deemed most important include “return risk in line with the expected interest rate”, “resilience to downside risk”, “stability of performance”, and “stable income”.
We also asked about ESG factors, and the results show that the percentages for "important" and "unimportant" were close to one another. Few respondents picked "very", suggesting that ESG factors are not very important to them, despite their adoption needs.
Overall, the need for low-liquidity assets remains high, and the market is dominated by products from asset management companies who respond to the need. The ESG market, which has been in the spotlight in recent years, seems to be gaining further momentum. Additionally, having experienced a number of market fluctuations since the 2008 financial crisis, including mini-crashes, Japanese pension funds seem to be building a resilient portfolio capable of withstanding the recent Corona shock.