Deutsche Asset & Wealth Management www.DeAWM.com S3 SPECIAL ISSUE Population ageing and capital market performance: Should we be worried? March 2014 Global Financial Institute Your entry to in-depth knowledge in finance Dr Paul Kielstra Population Ageing and Capital Market Performance Global Financial Institute Introduction to “Global Capital Markets in 2030“ Deutsche Asset & Wealth Management’s Global Finan- component of government debt; and stock markets face cial Institute asked the Economist Intelligence Unit to weakening demand in many mature markets produce a series of white papers, custom articles, and info-graphics focused specifically on global capital In short, while the world’s stock of financial assets (e.g market trends in 2030 stocks, bonds, currency and commodity futures) is growing, the pattern of that growth suggests that major shifts While overall growth has resumed, and the value lie ahead in the shape of capital markets traded on capital markets is astoundingly large (the world’s financial stock grew to $212 trillion by the end This series of studies by Global Financial Institute and the of 2010, according to McKinsey & Company) since Economist Intelligence Unit aims to offer deep insights the global financial crisis of 2008, the new growth into the long term future of capital markets It will employ has been driven mainly by expansion in developing both secondary and primary research, based on surveys economies, and by a $4.4 trillion increase in sovereign and interviews with leading institutional investors, corpo- debt in 2010 The trends are clear: Emerging mar- rate executives, bankers, academics, regulators, and others kets, particularly in Asia, are driving capital-raising; in who will influence the future of capital markets many places debt markets are fragile due to the large Population Ageing and Capital Market Performance Global Financial Institute Introduction to Global Financial Institute Global Financial Institute was launched in November are hundreds of years old, the perfect place to go to 2011 It is a new-concept think tank that seeks to foster a for long-term insight into the global economy Fur- unique category of thought leadership for professional thermore, in order to present a well-balanced perspec- and individual investors by effectively and tastefully tive, the publications span a wide variety of academic combining the perspectives of two worlds: the world of fields from macroeconomics and finance to sociology investing and the world of academia While primarily tar- Deutsche Asset & Wealth Management invites you to geting an audience within the international fund inves- check the Global Financial Institute website regularly tor community, Global Financial Institute’s publications for white papers, interviews, videos, podcasts, and more are nonetheless highly relevant to anyone who is inter- from Deutsche Asset & Wealth Management’s Co-Chief ested in independent, educated, long-term views on the Investment Officer of Asset Management Dr Asoka economic, political, financial, and social issues facing the Wöhrmann, CIO Office Chief Economist Johannes Mül- world To accomplish this mission, Global Financial Insti- ler, and distinguished professors from institutions like tute’s publications combine the views of Deutsche Asset the University of Cambridge, the University of California & Wealth Management’s investment experts with those Berkeley, the University of Zurich and many more, all of leading academic institutions in Europe, the United made relevant and reader-friendly for investment pro- States, and Asia Many of these academic institutions fessionals like you About the Economist Intelligence Unit The Economist Intelligence Unit (EIU) is the world’s lead- has included a variety of pieces covering the financial ing resource for economic and business research, fore- services industry including the changing role relation- casting and analysis It provides accurate and impartial ship between the risk and finance function in banks, pre- intelligence for companies, government agencies, finan- paring for the future bank customer, sanctions compli- cial institutions and academic organisations around the ance in the financial services industry, and the future of globe, inspiring business leaders to act with confidence insurance A published historian, Dr Kielstra has degrees since 1946 EIU products include its flagship Country in history from the Universities of Toronto and Oxford, Reports service, providing political and economic analy- and a graduate diploma in Economics from the London sis for 195 countries, and a portfolio of subscription- School of Economics He has worked in business, aca- based data and forecasting services The company also demia, and the charitable sector undertakes bespoke research and analysis projects on individual markets and business sectors The EIU is head- Brian Gardner is a Senior Editor with the EIU’s Thought quartered in London, UK, with offices in more than 40 Leadership Team His work has covered a breadth of cities and a network of some 650 country experts and business strategy issues across industries ranging from analysts worldwide It operates independently as the energy and information technology to manufacturing business-to-business arm of The Economist Group, the and financial services In this role, he provides analysis as leading source of analysis on international business and well as editing, project management and the occasional world affairs speaking role Prior work included leading investigations into energy systems, governance and regulatory This article was written by Dr Paul Kielstra and edited by regimes Before that he consulted for the Committee Brian Gardner on Global Thought and the Joint US-China Collaboration on Clean Energy He holds a master’s degree from Dr Paul Kielstra is a Contributing Editor at the Economist Columbia University in New York City and a bachelor’s Intelligence Unit He has written on a wide range of top- degree from American University in Washington, DC He ics, from the implications of political violence for busi- also contributes to The Economist Group’s management ness, through the economic costs of diabetes HIs work thinking portal 4 Population Ageing and Capital Market Performance Global Financial Institute Population ageing and capital market performance Written by A collaboration between Deutsche Asset & Wealth Managment‘s Global Financial Institute and Economist Intelligence Unit March 2014 Ageing: A developed- and emerging-market trend equivalent figures are 15% and 20% As the Chinese Rapid streams of numbers flashing across electronic example suggests, one way to reduce the impact of these screens in trading rooms and brokerage offices worldwide changes could be to increase the age at which employment seem to reflect the deeply impersonal nature of the world’s typically ends The political difficulties of doing so, however, capital markets raise questions about whether increases in the retirement Ultimately, though, these exchanges are driven by the decisions of individuals – whether age will keep up with advances in life expectancy executed as one-off trades or adopted as strategies programmed into machines Therefore, the attributes of A policy challenge the people buying and selling assets, as well as of the wider Older populations will require societies to make a wide populations in which they live, are intrinsically linked to range of adjustments, many with direct impacts on how markets perform This is most evident during a bubble national economies and, indirectly, on capital markets or an ensuing panic, where emotions can quickly inflate or According to respondents to a survey conducted by the destroy the value of any number of securities overnight Economist Intelligence Unit of 353 senior executives of More generally, though, any widespread changes to the companies actively involved in capital markets, one of prevailing needs, wants, productive capacity or views on the biggest predicted impacts of population ageing will risk in a society are likely to feed through, sooner or later, come from increased government spending to cover the to asset prices on capital markets associated costs in areas such as healthcare and pensions (cited by 41% of respondents) Several such shifts may be driven by societies’ ageing One economically important result of this demographic James Poterba, Mitsui professor of economics at the change is the increase in the proportion of people who are Massachusetts Institute of Technology, believes that retired and a reduction in their working-age populations “the greying of the population in the United States is an In 2010 in the developed world, according to data from important driver of long-term [government] spending to the United Nations Population Division, 16% were already GDP We are seeing that today.” America is far from alone 65 – a common retirement age – or older In the oldest This spending in turn presents societies with a fundamental societies, such as Japan, Germany and Italy, the figure was choice Alexander Ludwig, professor of macroeconomics at over 20% In the years ahead, for the developing world as the University of Cologne and an expert on the economics a whole, the total number of the over 65s is expected to of ageing, explains that governments can choose debt or rise by about 2% annually, so that it reaches 22% of the taxes to fund the coming spending needs for the elderly population by 2030 Too high a tax burden, though, will reduce savings by those in their middle years, and therefore investment in This issue also has particular resonance in Asia Because capital markets Too high a level of government debt, on China’s retirement age is 60, the proportion of people the other hand, may crowd out demand for other relatively beyond normal working years is 15% and is expected risk-free assets Furthermore, if households foresee that to reach 24% by 2030 This makes the issue much more higher debt today will have to be financed by increased immediate there than in the United States, where the taxes in the future, private spending will also go down 5 Population Ageing and Capital Market Performance Global Financial Institute According to Professor Ludwig, “it is certainly true that impact, though, will depend on the specifics – and the increased government spending will have an impact on success or failure – of the policies chosen to address the capital markets one way or the other” The shape of that changing needs of ageing societies 6 Population Ageing and Capital Market Performance Global Financial Institute A people challenge? ages – and therefore the time when retirement-related The difficulty in predicting what capital markets will expenditures begin – are not as solid as they seem, in part look like in a world where investors, like the population because people are, on average, healthier and therefore in general, are older is that the world has never seen able to work longer For example, in the United States population ageing on the current and predicted scale between 2003 and 2013, even without pension reform, the Hard data about what will happen not exist Expressions Bureau of Labour Statistics reports that the labour market of concern tend to begin with references to the life- participation rate of those aged between 65 and 69 rose cycle hypothesis This holds that, as individuals attempt from 27% to 33% Indeed, of those Americans still working to smooth out consumption over the years, they save at 65, the majority not retire And according to Statistics during their working lives and spend those savings in New Zealand, the labour market participation rate in that retirement to cover living expenses A higher proportion country for those over 65 doubled between 2002 and of retirees in the population therefore means that there 2012, from just under 10% to 20% Cultural differences are more people selling off accumulated capital assets may slow change International Labour Organisation (ILO) and fewer interested in buying, leading to a general drop data show that European countries, although they too in asset values Another issue – which survey respondents have seen some increase over the last decade, still have identified – is a shift by older, more risk-averse individuals very small labour market participation rates among the into traditionally safer investments, such as government elderly Nevertheless, as Professor Ludwig notes, even bonds, from more volatile ones such as equities Done en there, “if you live longer, and need higher savings, the masse, this would reduce share prices and lower interest average retirement age will probably increase without rates, as more retirees seek security in debt instruments regulatory reforms” This theory, however, is far from airtight While it has Looking for evidence substantial predictive value, this hypothesis ignores two These problems with the theory may explain why it has important investor motives: precautionary savings by the been difficult for researchers to find conclusive evidence elderly, who know neither how long they will live nor all – although population ageing has been taking place for the expenses they might face; and the bequest motive some time – of an impact on capital markets A study by As Professor Poterba notes: “Research of the last decade Professor Poterba, for example, found very little, if any, sign has shown that late life behaviour isn’t driven only by of a link between the changing age structure of the US drawing down capital A simple life cycle model is an population over several decades and the value of equities oversimplification.” or government debt in the United States It also found that, although household asset holdings rise when Similarly, any movement away from risk may be more people are in their 30s and 40s, they remain largely stable apparent than real For many individuals, pensions and throughout retirement except for defined benefit pensions annuities form a significant proportion of personal assets - which decline by design.1 in retirement Increasingly, however, the pension fund managers and insurance firms which oversee the assets The best evidence so far of a link between ageing and used to fund private pension payments are finding that equity values relates not to asset prices specifically, but to traditionally safe government bonds – long a default the price/earnings (P/E) ratios of equity assets Research asset for the industry – now pay far too little to meet their carried out by economists at the Federal Reserve Bank obligations to pension and annuity holders Therefore, of San Francisco found a surprisingly tight positive managers are buying a wider range of assets, including correlation between average US P/E ratios and the ratio alternative investments, in the search for yield of middle-aged people – which the study defines as those aged between 40 and 49 – and the old-age cohort likely to Furthermore, underlying assumptions about retirement be selling off shares – those aged 60 to 69.2 Presumably, James Poterba, “The Impact of Population Aging on Financial Markets in Developed Countries”, in Gordon H Sellor Jr, ed., Global Demographic Change: Economic Impact and Policy Challenges, Federal Reserve Bank of Kansas City, 2005, pp 163-216 Zheng Liu and Mark M Spiegel, “Boomer Retirement: Headwinds for U.S Equity Markets?”, FRBSF Economic Letter, August 2011 Population Ageing and Capital Market Performance Global Financial Institute where the number of middle-aged people is higher, their go beyond demographics to include areas such as pension greater interest in shares compared with other securities and labour market reform To address how this range drives up prices of issues might interact with ageing to affect capital markets in an internationally open economy, Professor Even with such an apparently good data fit, however, the Ludwig and his colleagues have put together a complex study warns that many other factors could obliterate this model.4 Its projections, though, vary dramatically based effect Moreover, Mark Spiegel, vice president, economic on government policy and individual lifestyle choices In research at the Federal Reserve Bank of San Francisco scenarios in which people take advantage of opportunities and one of the study’s authors, explains: “It is correct that to work later in life and where governments not reduce a lot of people hold a lot of scepticism The study works spending on pay-as-you-go pensions, the model suggests off very clear patterns in historical data, but you can tell a that asset returns will drop by about 5% between 2015 and special story for the sub-periods going back to the 1950s 2030, but then rise by the same amount again by 2050 for each of the big swings in the trends The ultimate test However, without a change in labour regulations and [of whether there is a link] is if it shows up in data [in the working habits but with a shift to funded pensions, which coming years].” increases the capital available, asset returns could drop by over one-quarter Put simply, the policy response is likely Examinations of other types of assets yield a similar to define how asset returns, and therefore capital markets, combination of possible pressure on asset prices owing to react to ageing ageing, alongside high levels of uncertainty about what might actually happen Real estate is one of the more Like most experts, Professor Ludwig advises caution The studied, as housing, along with pensions, is among the study itself suggests that continued high growth in Asia most widely held assets for retirees A Bank of International would counteract any downward pressure and more than Settlements (BIS) working paper which looked at house compensate for reductions in asset returns in several prices over 40 years in 22 countries found a link between scenarios Moreover, he warns that the available data ageing and lower prices It therefore predicted downward are based on the “baby boom” and “baby bust” years in pressure on prices resulting from older populations developed countries, which are insufficient to draw firm The paper stressed, however, that projected house price conclusions “This is why we have to work with simulation “headwinds” would be insufficient to produce an asset models grounded in economic theory,” he adds meltdown and offered the well-deserved caveat: “Longrun projections and estimates should be treated very Whatever the other uncertainties, Professor Ludwig, citing cautiously as their track record is dismal.” existing, separate research, feels confident that differential ageing patterns promote the flow of capital from older, The international dimension wealthier countries to younger, emerging markets.5 Others, Capital markets are not just about long-term assets, but also though, are less certain If this were the case, says Professor about flows of money International differences in the rate Poterba, “you would have expected North America and of ageing might affect these transfers and, indirectly, asset Europe to be large saving countries, to be lending to other values in different markets In particular, economic theory parts of world That is not what we see This reminds us that would suggest that investment should flow from wealthier, many other factors also affect capital flows – demography older countries with surplus capital and restricted labour is not everything.” supply towards developing, younger ones, where capital will be more productive and yield a higher return The most relevant economic theory, however, raises red flags about population ageing It could place some pressure Questions of international labour and capital availability on asset prices in the coming decades, and while the full Előd Takáts, “Ageing and asset prices”, BIS Working Papers No 318, August 2010 Axel Börsch-Supan and Alexander Ludwig, “Aging, Asset Markets, and Asset Returns: A View From Europe to Asia”, Asian Economic Policy Review, 2009 See, for example, Melanie Lührmann, “Demographic change, foresight and international capital flows”, Mannheim Research Institute for the Economics of Ageing, Discussion Paper 38-03, 2003 Population Ageing and Capital Market Performance Global Financial Institute scope is unclear, the extent does not seem likely to cause a What applies to rational markets hopefully applies to crisis Moreover, such evidence as exists does not provide rational policymakers Capital markets are not facing an solid support for strong predictions It may be unlikely ever unavoidable “silver tsunami” Population ageing may well to so: demographic changes are highly predictable A affect asset values, just as it will affect society in general, market made up of rational actors should foresee them but the way it does will be shaped largely by choices and may have already priced in any relevant risk Similarly, those societies make addressing the new demographic companies facing a reduction in labour capacity can alter environment their production models to ones that optimise the likely future mix of labour and capital 9 Disclaimer Global Financial Institute Deutsche Asset & Wealth Management represents the asset management and wealth management activities conducted by Deutsche Bank AG or any of its subsidiaries Clients will be provided Deutsche Asset & Wealth Management products or services by one or more legal entities that will be identified to clients pursuant to the contracts, agreements, offering materials or other documentation relevant to such products or services This material was prepared without regard to the specific objectives, financial situation or needs of any particular person who may receive it It is intended for informational purposes only and it is not intended that it be relied on to make any investment decision It does not constitute investment advice or a recommendation or an offer or solicitation and is not the basis for any contract to purchase or sell any security or other 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Written by A collaboration between... particularly in Asia, are driving capital- raising; in who will influence the future of capital markets many places debt markets are fragile due to the large Population Ageing and Capital Market Performance...2 Population Ageing and Capital Market Performance Global Financial Institute Introduction to “Global Capital Markets in 2030“ Deutsche Asset & Wealth Management’s Global