平成２５年８月６日
各位
一般社団法人

日本投資顧問業協会

CREATE－Research 社の報告書

このたび CREATE-Research 社の“Investing in a Debt-Fuelled World（邦
題：債務に煽られた世界における投資）”と題する調査報告書を、ホームページに掲載しました。同社は、英国の独立系のグローバルなコンサルティング会社
であり、金融、航空宇宙、IT、石油、製薬、テレコム等の幅広い産業をカバーしています。
同報告書には、資産運用業の将来に対する多くの示唆が含まれており、また、
同報告書の作成に際しては、当協会の一部の会員へのアンケートやインタビュ
ーの内容が反映されております。資産運用業に携わる方々にとって役立つものとなれば幸甚です。

以上Investing in a
debt-fuelLed world

Principal Global Investors is the institutional asset management arm of the Principal Financial Group®. Comprised ofa network of specialized investment boutiques and teams, it manages assets on behalf of public and private pension
funds, foundations and endowments, central banks, insurance companies, sub-advisory arrangements and sovereign
wealth funds.
The multi-boutique firm offers a single point of access to world-class investment boutiques and expertise in
fixed income, equity, and real estate investments as well as currency management, asset allocation, stable value
management, and other structured investment strategies.
For more information please contact: 1-800-533-1390 or principalglobal.com.
CREATE-Research is an independent think tank specialising in strategic change and the newly emerging businessmodels in global asset management. It undertakes major research assignments from prominent financial
institutions and global companies. It works closely with senior decision makers in reputable organisations acrossEurope and the US. Its work is disseminated through high profile reports and events which attract wide attention
in the media. Further information can be found at www.create-research.co.uk.

As with previous reports in the Principal Global Investors/CREATE-Research annual series, our researchrelied on a global survey bolstered by structured interviews.
Over 700 asset managers, pension plans, pension consultants, fund distributors and fund administratorsfrom 29 countries participated in the survey, with total assets under management (AUM) of US$27.4 trillion.
The survey was followed by 100 interviews with senior executives from a cross-section of survey respondents.
All the data presented in the report emanate from either the survey or the interviews.

Survey participants by geography and size of AUM
Australia

India

Singapore

Austria

Ireland

South Africa

Belgium

ItalySouth Korea

Canada

Japan

Spain

China

KuwaitSwedenDenmark

Luxembourg

Switzerland

Finland

Malaysia

TaiwanFranceNetherlands

UK

Germany

NorwayUS

Hong Kong

Saudi Arabia

AUM (US $ trillion)

27.4

Source: Principal Global Investors/CREATE-Research Survey 2013

Author: Prof. Amin Rajan
First published in 2013 by:
CREATE-Research
Vauxhall Lane
Tunbridge Wells TN4 0XD
United Kingdom
Telephone: +44 1892 526 757
Email: amin.rajan@create-research.co.uk© CREATE Limited, 2013
All rights reserved. This report may not be lent, hired out or otherwise disposed of by way of trade in any form,
binding or cover other than in which it is published, without prior consent of the author.

Foreword
Principal Global Investors is pleased to again partner with

Against this backdrop, this year’s research and resulting report

CREATE-Research in our fifth annual asset management

seeks to address five critical questions, with the key findings

research report. Professor Amin Rajan, chief executive ofcontained in the report’s Executive Summary:

CREATE-Research, is one of the most respected commentators on
the subject of asset management. This publication presents his
most recent research on investing in today’s debt-fuelled world.
Despite the notion that the global economy is running outof steam, neither Greece nor Germany exited the Economicand Monetary Union (EMU), and the euro did not implode;• What policy actions are likely to be taken by governments
on both sides of the Atlantic to reduce their spiralling debts
in the wake of the 2008 global financial crisis?
• What secular shifts will be reshaping the investment landscape?
• How will they affect investor expectations worldwide?

the Euro area is still holding together; calls for a US recession
missed badly and the US Congress scaled the fiscal cliff;
China’s economy has not crash landed; local governments
can still borrow; and US inflation is not raging.
But the recovery has been hard won and, in some cases,
remains fragile. The quantitative easing programme of the US
Federal Reserve, so spectacularly successful in the early yearsof the financial crisis, now looks to be a liability with interest
rates affecting retiree savings and sapping purchasing power.
The implications of low interest rates to Defined Benefit andDefined Contribution plans are evident. Add to that, the world’schanging demographics due to aging populations and it adds
up to a rapidly changing landscape. These challenging times
open opportunities for combining the best of today’s plans with• What approaches are likely to be adopted by investors ofvarious stripes?
• What can asset managers do to help their clients to manage
this transition?
We at Principal Global Investors recognize the need forstate-of-the-art products that fit clients, beginning with theaccumulation stage of investing and that seamlessly cross-overto decumulation as they enter the retirement phase of life.
Given today’s debt dynamic, we believe that it’s never been
more important to have a trusted investment partner, a longterm investment strategy and disciplined execution to help
navigate these demanding times.

new innovations in future pension products worldwide.
The net result is that global financial markets remain imbued
with heavy uncertainty and many investors lack direction.
This is evidenced in the findings in that the rising interest inreal assets is the biggest change from last year’s survey.

Jim McCaughanCEO
Principal Global InvestorsiAcknowledgements
This report presents the results of the 2013 global survey

findings in any way. This arms-length support has enabled us

in the annual research series started by Principal Global

to identify all shades of opinion on the emerging challenges in

Investors and CREATE-Research in 2009. The details of the

global investment and the responses they require.

previous reports are given at the end of this report.

Finally, I would like to thank two colleagues: Lisa Rajan for

Each year, the survey topic has been chosen after consultations

managing the survey, conducting the data analysis andwith thought leaders in the investment value chain around thesupervising the report preparation; and Dr Elizabeth Goodhew

world. This year, they wanted to know what investing meansfor editorial support.

in today’s debt-fuelled world.
My foremost thanks go to 713 top executives from around

After all the help I have received, if there are any errors andomissions in this report, I’m solely responsible.

the world who participated in our survey. One hundred of themwere also involved in our post-survey interviews, providing thenecessary depth, breadth, insights and foresight.
Prof. Amin Rajan
Many of them have provided unstinting support over the years

Project Leader

towards creating an impartial research platform that is now

CREATE-Research

widely used in all the fund markets around the world.
I would also like to thank Principal Global Investors, who hassponsored the publication of this report without influencing its

iicontents
Forewordi

Acknowledgementsii

Executive Summary2

Report Synopsis

6

Personalisation of Risk:

16

What are asset managers doing to facilitate
the switch from DB to DC?

Pension Market Investors

28

What goals, strategies and asset classes will
they pursue?

Mass Market Investors
What goals, strategies and asset classes will
they pursue?

38

|

1 Executive Summary“

Past losses and ageing populations
are driving investors away fromconventional investing. Solutions
alpha will be the most enduring
legacy of the 2008 crash.

- an interview quote”

INTRODUCTION
The Eurozone has not broken up. America has not fallen
off the fiscal cliff. China’s economy has not crash landed.
The world has not suffered an oil spike. The dire predictions
about the recent past have been confounded.
Markets have rallied due to receding worries as much asdecisive action by central banks on both sides of the Atlantic.
The quantitative easing (QE) programme of the US Federal
Reserve has reinforced the recovery and created some
two million jobs out of five million since 2009.
Bold moves by the European Central Bank (ECB) haveaverted the demise of the Euro and given governments
precious time to enact reforms to tackle the unsustainablelevels of their debts.
The sentiment that the crisis may be over has itself served toease it. Yet fear continues to lurk in the background, due tothe exceptional market volatility sparked by the deleveraging
now in progress.

2

Little is documented on the force of its undercurrents andtheir impact on investing in this decade. That is the main aimof this report.
This report addresses these five important questions:• What policy actions are likely to be taken by governments on
both sides of the Atlantic to reduce their spiralling debts inthe wake of the 2008 global financial crisis?
• What secular shifts will be reshaping the investment landscape?

Investors fear financial repression while
deleveraging remains a slow-burn issue
The start of 2013 saw the return of the feel-good factor.
Markets have rallied. The fear of another 2008-type meltdown
has receded. But hopes of another 2009-type bounce remainslim. Despite a variety of policy actions on both sides of theAtlantic, progress on debt reduction will be slow and patchy.
In Europe, deleveraging will be led by low interest rates,
rising inflation and austerity. The latter is already proving• How will they affect investor expectations worldwide?

self-defeating. Most of Europe remains in recession.

• What approaches are likely to be adopted by investors of

By contrast, in the US, deleveraging will be led by economic

various stripes?
• What can asset managers do to help their clients to manage
this transition?

growth, low interest rates and rising inflation. The economic
recovery is already driving down the debt-to-gross domestic
product (GDP) ratio in a positive chain reaction.

The industry as a whole will have to adopt new time horizons

Yet the survey respondents remain guarded about the progress

and navigate shifting returns and yields. This will require newover the next three years: only 10% expect significant progressapproaches and asset managers will need to help clients toin Europe and only 29% expect significant progress in the US.

adapt and advance.

3executive summary
Hence, questions persist. Will there be an accord on deficit•

continued

Retirement age will continue to rise in line with life expectancy.

reduction in the US? Will the Federal Reserve’s exit strategy turn

Risk will be shared between sponsors and their employees, withwhat is now a stabilising force into a destabilising force?

the imminent rise of the Defined Ambition plans.

Likewise, will the ECB’s actions merely prop up weak banks inthe Eurozone? Will its member governments have the will to•

immunisation via liability driven investment (LDI).

persist with unpopular measures against the populist tide?
Will the new leadership in China implement reforms, which
improve the country’s growth prospects and avoid asset bubbles?

In the private sector, the key aim will be progressive risk•

In the public sector, it will be capital growth, enabled bytaxpayer backstops.

Accordingly, politics, more than economics, will drive the

These changes will be accompanied by an unprecedented switch

markets. Investors are braced for market-moving events thatto Defined Contribution (DC) plans, which will hold the bulk of

may potentially result in big gains or big losses.

the global pension assets by the end of this decade.

Investors are also worried about the revival of a long-forgotten

Risk will be personalised.

phenomenon: financial repression. This is caused when central

Investors will lower their expectations about
returns and pursue other goals

banks keep the rates artificially low for a long period of time inan effort to help governments finance their debts. It is fearedthat a combination of low rates and rising inflation will steadily

There is no free lunch with the quantitative easing (QE)

vaporise public debt and erode the purchasing power of the

programmes. They require exceptional foresight and luck.

underpinning assets.
Investors fear being on the losing side in this arbitrary
redistribution of wealth that could last for at least 10 years,
if history is any guide.

QE programmes have stretched relative valuations in favour ofrisky assets to create the ‘wealth effect’ that will boost the real
economy, create new jobs and expand the price-earnings (P/E)
multiples. The green shoots of this multiplier effect are moreevident in the US than Europe. But opinions of those surveyed

The pension promise will be rewrittenby this report differ:

The pension promise was easy to make but hard to keep. It will

• 40% of our respondents see QE as a tonic for reviving growth

be downsized.
• 35% see it as inflationary
In particular, the closure of Defined Benefits (DB) plans will
accelerate in all the pension markets due to a double squeeze:
low discount rates on the liability side and low returns on

These numbers mark an improvement over our 2012 survey

the asset side. Their persistent deficits require average annual

results. But their message is clear — barring a sudden

returns in excess of 6.5% — a tall order by the standards ofimprovement, investors see themselves in a new era in which

the last decade.

their expectations about growth, inflation and returns have to•

Schemes will be closed to new members as well as toexisting ones.

•

Capital injections will become inevitable in order to retain
plan solvency. In return, member benefits will be scaled back.

4• 25% see it as deflationary

be reassessed.
Investors expect bond yields to remain low at least until 2015.
Low yields can fuel equity markets. But they can also presage
deflationary outcomes. In any event, equity valuations areexpected to revert to their fundamentals, as successive roundsof QE generate diminishing outcomes.
High returns will no longer be the be-all and end-all. Investors
will adopt eclectic approaches. Caution will prevail alongside
opportunism. The chase for returns will prevail alongside
the chase for other goals, for example: capital conservation,
inflation protection and regular income.

Alpha will be in the eye of the beholder
The implied shift in pension risk from sponsors to employees“”

We were selling cars in kit form.
Baby boomers need assembled
vehicles that get them from A to
B, while pushing complexity under- an interview quotethe bonnet.

How asset managers help their clients navigate thetransition will differentiate winners from losers

will be marked, as will the convergence of the retail market andPersonalisation of risk has a big downside. It transfers risk

the retirement market in the West. Over the next five years, up

from those who couldn’t manage it to those who don’t

to 75% of retail assets will be held by baby boomers born in theunderstand it.

period 1945-1965. Many of them are not in DB plans.
Solutions will be in the eye of the beholder.

A lot is being done to improve financial literacy. But today’s
investing requires a degree of proficiency far in excess of whata typical investor can ever hope to attain. Asset managers

Both DC plan members and their retail peers will increasingly
distinguish between ‘product alpha’ and ‘solutions alpha.’
Product alpha is about beating the markets, solutions alpha isneed to make investors’ worlds easier. Their product offerings
need to embody advice mechanisms such that ‘doing-nothing’on the part of investors is itself financially savvy.

about meeting investors’ pre-defined needs. Solutions alphawill remain the epicentre of innovation.

In addition three complementary actions that meet thechallenges presented by deleveraging will be critical toLatest examples include LDI in the DB segment, life-cycle

those operating in the new financial landscape:investing in the DC segment and advice-embedded investingin the mass market segment. A critical mass of early adopters•investors capitalise on the opportunities created by theis already there. Late adopters are not far behind.

debt dynamic (according to 67% of survey respondents)

Approximately 60% of the survey respondents expect further
growth in each of these areas over the next three years.

They must develop new investment capabilities to help•

They must improve client engagement to better understandclients’ needs, liabilities and risk tolerances (60%)

Legacy assets will migrate towards solutions
driven investing. The emerging trend will be as
immutable as the momentum of a super tanker.
Today’s peripherals will be tomorrow’s mainstream.

•

They must improve the alignment of interest so they candeliver products that better fit the purpose within a valuefor-money fee structure (45%)

Overall, deleveraging will leave a lasting impact. This is further
developed in the eight themes that follow.

Conventional investing will morph beyond
recognition by the end of this decade.

5|

2 report synopsis“
6

The credit crisis has beena turning point. It is forcingchanges that can benefit
investors in the long run.

Overview- an interview quote

They add further colour to the findings as well as provide”

The previous section provided the key findings fromthe research via five headline messages.
This section proceeds to provide a synopsis of this reportthrough eight core themes.

the underpinning data.

Theme 1:

A catch-22 will characterise the dynamics of deleveraging
Since the 2008 crisis, financial markets around the world haveits inherent resilience. That it has yet to produce a long-term plan

been largely influenced by the debt crisis on both sides of theto reform its finances speaks to its continuing political paralysis.

Atlantic. Macro considerations have overwhelmed micro factors.

Investors are unsure whether the current market rally can outlive

The deleveraging now in progress in Europe and America is part

central bank action.

of a bigger narrative that goes beyond cutting the public debt.

In contrast, Europe will remain caught in a vicious cycle, triggered

When banking losses were socialised after the Lehman crisis,by two slow-burn issues: austerity and reforms. Both are taking

what started as a financial problem turned into a structural one.

their toll on growth, jobs and tax revenues. Only Germany, theBig government deficits dented confidence and hit growth.

Netherlands and Sweden have avoided them. Europe’s will be a

The resulting cuts in public expenditure made matters worse.

jagged recovery, fraught with policy errors and negative surprises.

Had growth been maintained at its average level between1990

The view from the survey is that the global economy will thus

and 2007, GDP would have been some 15% higher by 2013, as

experience a two-speed recovery with Europe in the slow lane, andwould the tax revenues. Austerity, or reforms of public finances,

the US and emerging markets in the fast lane. Economic growth inhas proven to be self-defeating in the short-term. Yet, without

the fast lane, however, will still be below historic averages. Countries

them, investors fear financial repression.

like China, Taiwan and South Korea are maturing into developed

So, governments will use a mix of five factors to drive down theirdebts (Figure 2.1). In Europe, the main thrust will be led by cutsin public spending, low interest rates and reform of publicfinances. In the US, it will be led by economic growth, low interest
rates and rising inflation.

economies, after a long period of double digit growth. Others like
India and Brazil are running into structural barriers which require
governance reform. As a result, key commodity suppliers like
Australia and Canada will experience sub-par growth. The impliedtransition will not be easy, however, while their major markets —Europe and the US — continue to wrestle with deleveraging.

The fundamentals of the US economy look good due to a pick-up

3% itsin the housing market, job market and energy production. With

INTERVIEWQUOTES:78%

budget deficit already on a downward path, it appears that the 19
US%“Europe accounts for 7% of the world population,
25% of its output and 48% of its welfare expenditure.”economy may soon be reaching ‘escape velocity.’ It holds surprises
on the upside.
After the 2008 crisis, emerging markets lifted the global economy.
After the steep downturn in 2011, that locomotive role has fallen on“The US health care budget accounts for 18% of GDP,eight percentage points higher than the OECD average.”
0.0
0.2
0.4
0.6
0.8
1.0

the US. At around 2%, though, the economic growth in the US will
not be stellar enough to make a big dent in its own budget deficit.
That the US managed to avoid a double-dip recession despite the“Inflation is a polite way of reneging on promises
made by governments.”

political hiatus around the debt ceiling and ‘fiscal cliff’ speaks tofigure 2.1
70Europe60% of respondents

Which avenues are most
likely to be used bygovernments on both sidesof the Atlantic to tackle
their debt problems overthe next 3 years?

USA

50
40
30
20
10
0
Economic
growthRisinginflation

Cuts in public
spending

Low interest
rates

Reform of publicfinances

Source: Principal Global Investors/CREATE-Research Survey 2013

7

Theme 1 continued
When asked whether governments will be able to make(OECD) countries. The pre-occupation with the financial crisis

significant progress in reducing their debts over the next

has diverted policy attention from the important to the urgent.

three years, once again a trans-Atlantic divide emerged inour respondents’ assessment.

Third, central banks have their own detractors. The current QE
programmes of the US Federal Reserve, Bank of England, Bank

Responses for Europe err on the side of pessimism:of Japan and Bank of Switzerland are the biggest monetary• 12% ‘Yes’• 19% ‘Maybe’

experiments in history, essentially journeys into the unknown.

• 39% ’No’

• 30% ‘Not sure’

Their possible outcomes range from a big economic turnaroundResponses for the US err on the side of cautious optimism:

to a 10-year flat line.

• 30% ‘Yes’• 23% ‘Maybe’

They have already succeeded in their early intent: to stimulate• 18% ‘No’

• 29% ‘Not sure’

demand for risky assets. Whether they will create a lasting ‘wealtheffect’ that ramps up growth and jobs remains an open question.

Behind these numbers lie a number of salient points.

The conventional monetary multipliers appear less potent.

First, it took 20 years to build up the excessive leverage thatcaused the 2008 crisis. It is too much to expect it to be rolledback within five years. The visceral populist anger against banks
has made it ever harder to drive reforms that affect the general

The feel-good factor is returning. But fear will continue to lurkin the background until monetary stimulus is complemented bysupply-side reforms in the West.

public. Elections, too, have gotten in the way of serious debates

INTERVIEW QUOTES:

on spiralling welfare costs in the face of ageing populations.

“Investors will continue to keep their powder dry until theysee improvements in the real economy.”

Even so, some progress has been made at the European Union’s(EU) periphery: Greece, Ireland, Italy and Portugal.
Second, central bank action has prevented a global disaster. But
it is no substitute for reform. Even before the crisis, demographic
trends were having dramatic effects on health care, welfare
budgets, labour markets and national competitiveness in all
the Organization for Economic Co-operation and Development“Central banks don’t have many bullets left in the gun.
They’ve won time for governments. They’ve not won
the game.”“Will politicians stop kicking the can down the road andadopt sensible deficit reduction plans?”

figure 2.2
Europe

40

USA

30

% of respondents

Do you expect governments
on both sides of the Atlantic
to make significant progressin reducing their debts overthe next three years?

20

10

terestes

Reform of publicfinances0

Yes
Source: Principal Global Investors/CREATE-Research Survey 2013

8

Maybe

No

Not SureTheme 2:

The 2008 crisis and ultra-low rates have proved the final
straw for pension plans
A lethal mix of market losses, ultra-low interest rates, marked-to-

In addition, corporate plan sponsors will be making cash injections

market accounting rules and ageing populations has made DB

to raise funding levels in order to minimise risk via LDI. Buyouts willplans ruinously expensive for their sponsors.

remain the end-game in the private sector.

They are being closed to existing members as well as new members,

In the public sector, plans will continue to benchmark assets, notas sponsors switch to DC plans. 63% of asset managers and 56% ofliabilities. They will dial up risk and/or extend the duration of theirpension plans in our survey expect the closure rate to accelerate.

recovery plans, thanks to taxpayer backstops. Before long, however,public sector plans will feel the squeeze as well. They will be obliged

By the end of this decade, DB plans may well be the preserve of
the public sector. Even in rock-solid DB markets like Canada, Japan,
the Netherlands and South Korea, the pension promises have been
hard to honour.

to adopt a market-based discount rate for calculating their future
liabilities. This is already happening in Japan, South Korea and the US
Overall, around 25% of all plans will be on an LDI trajectory by

Only 24% of all plans have a funding level in excess of 100% (Figure
2.3, left-hand chart). That figure was 40% in 2011, according toresults of our 2011 survey. The drop reflects falling discount rates on
the liabilities side and falling returns on the asset side.
The annual returns required for plans to stay open seem overly
optimistic in the low-yield environment of this decade (right-handchart): 81% of the plans require returns in excess of 5% and the2020. For very one plan that dials up risk, there will be anotherthat will dial it down.
The DB landscape will change irrevocably.

INTERVIEW QUOTES:“Some state plans in the US have 60-year recovery
periods, so low are their funding levels.”remaining 19% require over 8%. These targets appear ambitious“In DB plans, the rate of inflows runs into single digits
plans with higher deficits require higher returns. Hence, apart from and the rate of outflows into double digits.”in the light of the actual outcomes in the last decade. In general,closures, a number of one-off changes are in the pipeline.
In the private sector, they include discretionary indexation, an“It’s very hard to get returns in excess of 5% without
leverage or aggressive risk-taking.”

increase in the retirement age and higher member contributions.

figure 2.3
What is the current funding level of your DB plan? What annual total returns on your assets would meetyour long-term funding needs?
funding levels

24%

33%
fig 1.3

23%

20%

target returns

33%

24 19

Below %
80% %

22%
%

19%

22%
%

80 - 90%20
33%%

91 - 100%23% Over 100%

Up to 5%
5.1 - 6.5%

26%

33%

26%

6.6 - 8.0%
Over 8%Source: Principal Global Investors/CREATE-Research Survey 2013

9

Theme 3:

New diversification is targeting a multiplicity of goals in the DB space
In the face of unprecedented volatility and ultra-low yields

smart beta to obtain cheap alpha. The third option involves

since 2008, DB investors have been migrating from old style

going down the LDI route by hedging out unrewarded risks anddiversification that targeted returns to one that targets end-goals.

using a variety of assets to enhance dedicated portfolio returns.

The evolving approach seeks to minimise correlations at different

Going forward, a clear distinction has emerged between means (boxmarket phases via dynamic investing.

three) and ends (box four). The ends include: capital growth, high

The new approach has evolved from previous ones (Figure 2.4).

income, regular cash flows, high liquidity and inflation protection.

In the 1990s, DB plans’ asset allocation followed a formulaic path

The numbers in the boxes are indicative and not definitive: theythat favoured overweight positions in equities (box one).

apply to large pension plans on both sides of the Atlantic.

After the losses in the 2000-2002 equity bear market, there was

Additionally, some plans also have a hedged portfolio to provide aa significant switch to alternatives and exotic beta — the latter

glide path for the LDI, some make extensive use of smart beta andtargeted new areas like commodities, forestry, currency andsome use risk factors in asset allocation.

exchange-traded funds (ETF) (box two). But the losses in 2008,

Early adopters of this outcome-oriented investing already exist inonce again, led to another rethink.

all the pension markets — in private and public sectors. Starting inSo, by the beginning of this decade, three clear distinctions

Europe, the concept is already spreading to Canada and the US inemerged in the portfolio (box three): between alpha and beta;

the West, and Australia and Japan in the East.

between opportunistic investing and buy-and-hold investing; and

INTERVIEW QUOTES:

between re-risking and smart-risking. While the first two distinctions
had been evolving in the last decade, the third one came rapidly
to the fore in this decade, when pension plans were left with three
options to cut their deficits.

Options to Cut Deficits
The first option involves dialling up the risk by venturing further
out on the risk curve in search of higher yielding assets. The
second option involves getting more returns from existing risk
budgets by using market indices to create non-cap-weighted“Around 80% of our investments in equities rely on
traditional indexed funds and smart beta.”“Investors prefer safety at the expense of returns
due to the growing worries about the stability of
the global financial system.”“As our liabilities mature, we need regular income andinflation protection to meet day-to-day needs.”

figure 2.4
How will DB plans go from static to dynamic allocation and from asset focus to liability matching over the
next three years? (percentage of total assets)

1990s
40%
Bonds
60%
Equities

8%
Exotic beta
22%
Alternatives
70%
Long only

5%
Inflation protection: TIPs, commodities

25%
Alpha assets
75%
Beta assets

10%High liquidy: Cash, Treasuries

35%
Opportunistic investing65%
Buy-and-hold investing
15%
More risk for more return
85%
Same risk for more return

HEDGED PORTFOLIO

2000s

%

2010-201215%
Cash flow assets: Property, infrastructure
20%
High income: Bonds, credit
50%
Growth assets: Public equities
RISK FACTORS

Source: Principal Global Investors/CREATE-Research Survey 201310

SMART BETA

2010-2015

Theme 4:

Personalisation of risks is ushering in a new era for solutions alphaIn all the pension markets, governments are looking to reducepredefined outcomes mostly via beta, based on multi-asset classes

retirement benefits. Employers, too, are shedding spirallingand dynamic investing. It cuts across style boxes and asset classes,

pension liabilities to de-risk their balance sheets. Insurancewith embedded risk tools and distinct alpha sleeves in some cases.

companies are pulling out of the annuity markets due to low rates

The complexity is kept under the bonnet.

and rising life expectancy. Risk is being personalised. Individuals
are being obliged to bear the brunt of all risks in retirement
planning. They have to work longer, save more and spend less.

In each market segment, the ranks of early adopters are growing.
Ever more DB assets will migrate towards funds identified in
the lower three boxes of Figure 2.5, aided by a combination

The emergence of solutions alpha is the flip side of this trend.

of demographics, ultra-low rates and ‘nudge economics’ that

It does not target market-beating returns, since they have provencapitalise on investor foibles.

elusive and expensive. Instead, it targets specific outcomesthat meet investors’ needs. It also aims to avoid the ‘sequenceof returns’ risk that can severely hurt retirement portfolios:

Even in BRIC economies, the main thrust of financial education
will increasingly promote retirement planning via buy-andhold investing. Chase for quick returns via momentum-driven

after a big loss, the ability of the portfolio to catch-up during

investing has cost retail investors dearly. With the exception ofsubsequent years is greatly diminished.

India and Indonesia, ageing populations will continue to change

In the past, investors chased high returns in the belief that they

investment approaches.

would be enough to meet their eventual (often unquantified)

Solutions alpha will come of age.

retirement and other needs. This assumption only held in theraging bull market of the 1990s. Two punishing bear markets

INTERVIEW QUOTES:

since then have fed risk aversion and solutions alpha in equal“Inflation is a phantom tax on retirees, when their nest
eggs roll over into bonds.”

measures (Figure 2.5).
Starting with LDI in the DB space, it has spread to the otherinvestor segments as well: for example, target date funds in the
DC space and diversified income funds in the mass market space(Figure 2.5). In these and other cases, solutions alpha targets“10,000 Americans and 14,000 Europeans are retiring every day.”“There’s no place for beta jockeys dressed up as alphamanagers. Investors have wised up.”figure 2.5 	What is solutions alpha and what form does it take with three core investor groups?
Investorgoals

Deep investor
knowledge

Solutions alpha• Pre-defined outcomes• Embedded risk management• Multi-assets• Dynamic asset allocation• Separation of alpha and beta
• Complexity under the bonnet

DB plans

DC plans

Mass market• LDI• Risk mitigation solutions• Longevity insurance• Bulk annuities• Implemented consulting• Target date funds• Target risk funds• Target income funds• Deferred annuities• Diversified growth funds• Diversified income funds• Inflation protection funds• Low volatility funds• Absolute return funds• Variable annuities

Based on broad diversification that:
Deliveryvehicles• Cuts across style boxes• Relies on passive funds• Has alpha sleeves

Deep productcapabilities

Source: Principal Global Investors/CREATE-Research Survey 201311

Theme 5:

The next wave of innovation in the DC market will be themost ambitious yet
Today, global pension assets amount to circa US$30 trillion, ofa minimum 10% deferral rate via auto-escalation and minimum

which the DC plans hold 43%. By the end of this decade, with

90% of members invested in advice-embedded products, suchthe accelerated closures of DB plans, this share will exceed 60%.

as target date funds, with a pre-set glide path for asset allocation.

There is a widely-held view that, instead of throwing the baby

Some are changing the target date structure to provide guaranteedout with the bath water, there’s a lot in the DB plans which canmonthly income during retirement by replacing the traditionalbe incorporated into the next wave of DC products.

fixed income assets with a pool of unallocated deferred annuities.

When asked to indicate the extent to which this has alreadySome plans are adopting the more ambitious concept of a target

happened (Figure 2.6), asset managers and pension plansincome fund. It shifts the emphasis from asset maximisation to

responded as follows:

liability matching based on five needs:• 71% of asset managers and 58% of pension plansanswered ‘some extent’• 40% of pension plans also answered ‘not at all’

• Income• Inflation protection• Capital conservation• Health care

• Bequests

The desirable features include:

It shifts attention from short-term returns to life-style planning. Not• Clarity about financial needs in retirement

achieving the retirement goals will be their key measure of risk.

• Higher and realistic contribution rates

As in the DB market, so in the DC market, the early adopters of• Seamless rollover of assets from the accumulation to thedecumulation phasesolutions driven investing are already there. Even in trustee-run
markets, like Australia and the Netherlands, DC assets will be• An LDI-lite facility which targets a retirement income
benchmark from the outset

migrating as late adopters arrive on the scene. Early expression of• Broad diversification which exploits risk premia from a variety
of sources

INTERVIEW QUOTES:• Dynamic asset allocation which exploits periodic pricing
inefficiencies“Life-cycle funds will morph into a holistic product coalescingthe ‘to’ retirement and ‘through’ retirement phases.”interest is evident in Brazil, Hong Kong, Singapore and South Africa.

Recent innovations have focused on life-cycle investing, which“Target income funds hold great promise forAustralian investors.”

is gaining momentum in every DC market. They emulate someof the above features while closing the gap between the ‘to’retirement and ‘through’ retirement phases.

“Without advice-embedded products DC plans will go
the same way as DB plans.”

Some plans are adopting the so-called ‘90-10-90’ strategy: aminimum plan participation of 90% via auto-enrollment,

figure 2.6

80
70
60

% of respondents

On the whole, to what extent do
the available DC products in yourjurisdiction embody the desirable
features of DB plans currently?

50
40
30

Asset managers

20

Pension plans

100

Source: Principal Global Investors/CREATE-Research Survey 201312

Large extent

Some extent

Not at all

Theme 6:

Equities, credit and real estate will remain attractive
Progress on political and economic fronts in the US is seen as vital

For medium-term asset allocation, between 47% and 63% of

for a sustained market recovery globally.

respondents expect DC investors to engage in asset allocation via
balanced funds, traditional indexed funds, target date retirement

Solutions alpha will drive the undercurrents of investing by DB
and DC investors. In the process, investors will draw a distinction
between short-term opportunism and medium-term asset

funds, actively managed funds and target income funds (SouthEast box). The weight of new money will go into three elementsof life-cycle investing: target date funds, target income funds andallocation (Figure 2.7).

target risk funds.

Between 33% and 49% of our respondents expect DB investors
to engage in opportunism via five asset classes: distressed debt,
ETFs, high yield bonds, commodity funds and small cap equities(North-West box).
Between 44% and 56% also expect DB investors to engage inBoth DB and DC investors see beta and cost as the main driversof returns. ETFs are seen as low-cost liquid options, with thepotential to deliver excess returns via smart beta.

INTERVIEW QUOTES:

asset allocation via six asset classes: global equities, real estate,traditional indexed funds, emerging market equities, emerging
market bonds and alternative credit (North-East box).

“Equities will be the prime beneficiaries of the central
banks’ most unusual financial experiment in history.”

Clarity on policy issues will see expansion in earnings multiples
for equities. More immediately, two asset classes are likely to
attract big inflows as the search for yield intensifies: real estate
and alternative credit (e.g. senior loans, commercial mortgages,and ‘secondaries’ in private equities). These are viewed as ‘crossover’ assets with bond-like features and equity-type returns.
Turning to DC investors, between 15% and 42% of respondents
expect them to engage in opportunism via ETFs, actively“Being claims on company profits, equities cannot
diverge too much from the fortunes of the real
economy.”“Interest in real assets and credit will grow at theexpense of bonds.”

managed funds, diversified growth funds, indexed funds andcustomised plans (South-West box).

figure 2.7 Which asset classes are pension investors likely to choose for short-term opportunism andfor medium-term asset allocation?
DB investors% of respondents% of respondents

High total returns
Distressed debt
ETFs
High yield bonds
Commodity funds (incl gold)
Small cap equities
Tacticalopportunism

Returns & liquidity
49%
44%
42%
37%
33%

Global equities
Real estate (debt and equity)
Traditional indexed funds
Emerging market equities
Emerging market government bonds
Alternative credit

High total returns
ETFs
Actively managed equities/bonds
Diversified growth funds
Traditional indexed funds
Customized investment plans

Source: Principal Global Investors/CREATE-Research Survey 2013

56%
55%
53%
52%
44%
44%

Capital enhancement
42%
32%
24%
18%
15%

Balanced/multi-asset class funds
Traditional indexed funds
Target date retirement funds
Actively managed equities/bonds
Target income retirement funds

Asset
allocation

63%
59%
58%
51%
47%

DC investors

13

Theme 7:

Loss aversion in the West and search for high yield in the East
will characterise mass market investing
In the West, over the next five years, up to 75% of retail assets

West box), while their peers in the West will pursue a multiplicity

will be held by baby boomers born during the period 1945-of goals through a variety of asset classes (South-East box). The

1965. The convergence between the mass market and thegoals will include capital protection, capital growth, regularretirement market will accelerate. Retirees and near retirees

income, inflation protection and catastrophe avoidance.

are still nursing big losses from the last decade. On the bondside, too, the arithmetic of today’s low yield sits uncomfortably
alongside rising longevity. Low rates are driving up duration bystealth and hastening the move towards solutions alpha.

For retail as well as HNWI, the migration towards solutionsdriven investing will entail a growing use of passives, involving
traditional indexed funds and ETFs.
There are, however, some concerns that the growing use of ETFs

Between 36% and 48% of our respondents expect retailin particular will distort the price discovery mechanism, increase

investors to become opportunistic via ETFs, theme funds andasset class correlations and conceal the divergence in their time-

actively managed funds (North-West box in Figure 2.8).

weighted returns and dollar-weighted returns.

Opportunism will be rife in emerging markets, as exemplified by
the wealth management products in China. The search for highyield will be driving investors into such opaque products from theshadow banking system. They resemble the bonds that sliced anddiced the sub-prime mortgages in the US pre-2007.
On the asset allocation side, between 50% and 65% of respondents
expect retail investors to pursue funds with an income focus, active

INTERVIEW QUOTES:“If you can’t stomach 30% volatility, don’t invest in
Chinese stocks.”“In Asia, there is a desperate hunt for yield akin to the one
for sub-prime mortgage bonds before the 2008 crash.”funds, indexed funds and capital protection funds (North-East box).
Caution will remain the watchword for retail investors in the West.
Turning to high net worth individuals (HNWI), those in the East
will chase absolute returns via opportunistic investing (South-“Most retail investors can’t afford another ‘lost
decade.’ They are not in DB schemes and risk outliving
their savings.”

figure 2.8 Which asset classes are mass market investors likely to choose for short-term opportunismand for medium-term asset allocation?
Retail investors% of respondents% of respondents

High total returns
ETFs
Theme funds (e.g. Shari’ah, SRI,
wealth mangement)
Actively managed equities/bonds
Tacticalopportunism

Funds with income focus
Actively managed equities/bonds
Traditional indexed funds
Capital protection funds

48%
37%
36%

High total returns
ETFs
Commodity funds (including gold)
Currency funds
Hedge funds
Actively managed equities/bonds

Source: Principal Global Investors/CREATE-Research Survey 201314

Income and low volatility
65%
53%
52%
50%
Asset
allocation

Capital enhancement
44%
44%
35%
34%
32%

Actively managed equities/bonds
Real Estate
Balanced/multi-asset class funds
Hedge funds
Private equity
HNWI

58%
55%
49%
47%
47%

Theme 8:

Asset managers have to decouple marketing from thought leadershipif they are to go from distant vendors to trusted advisors
Markets remain disconnected from their fundamental value drivers.

unusual environment. They should also solicit client feedback

Many see investing as a ‘loser’s game’: where the winner is not theregularly and act on it.

one with the best strategy, but one who makes the fewest mistakes.

The third area centres on alignment of interest. Asset managers need

The scope for errors is large, especially when there is no consensus

to promote co-investing, adopt meritocratic fees, avoid me-tooon the possible impact of the QE programmes. 35% of the

products and offer proactive investment ideas. Above all, they needparticipants in our post-survey interviews see them as delivering

to upgrade their risk models.

inflation. A further 30% see them as delivering deflation, as low yieldpromotes imprudence in public finance and undermines the viabilityof the finance sector. The remaining 35% see them as a motor for
reviving growth and facilitating reforms.

Many of the current generation of risk models do not cope withextreme events, or with path dependency that allows returns in one
period to influence those in the next, or with the effects of investors’
own actions, or with risk factors that provide protection during

Investors want asset managers to embrace solutions alpha and add

market dislocation.

value in three areas (Figure 2.9).
The first one centres on investment capabilities. Asset managers
need to develop a deeper understanding of the debt dynamic, its
hidden traps and its hidden opportunities. They also need to create
opportunity sets in the credit space as banks withdraw from it under
Basel III. Finally, they need to offer an integrated solution.
The second area centres on client engagement. Asset managers
need to understand their clients’ needs and risk tolerances.
They need to avoid unrealistic claims about returns and manage

INTERVIEW QUOTES:“Fundamental correlations will resume only whenmarkets are driven by fundamentals.”“Asset managers’ risk models need a big make over,as investors move towards risk-based diversification.”“Technology has improved our measurement of risk
but not our understanding of it.”client expectations of what can and can’t be delivered in today’s

figure 2.9 What do asset managers need to do to deliver solutions to their clients?

CLIENT ENGAGEMENTINVESTMENT CAPABILITIES• Develop deeper understanding of the debt dynamic and its impact• Understand client needs, liabilities and risk tolerances• Exploit asset class correlations during different market phases• Conduct regular client pulse checks and act on feedback• Create new opportunity sets in the credit space• Create client protection panels to champion client interests• Spot value opportunities and value traps• Manage expectations on what can and can’t be delivered• Provide an integrated solution via implemented consulting• Avoid unrealistic claims about returns

INTEREST ALIGNMENT• Promote co-investing and share pain and gain with clients• Avoid me-too products and only provide ones that are fit for purpose• Deliver proactive investment ideas and buying opportunities• Upgrade the risk overlay and do frequent stress tests• Avoid peer herding
Source: Principal Global Investors/CREATE-Research Survey 201315

|

3 Personalisation of risk“

People have to work longer,
save more and spend less.
The pension world will neverbe the same again.
- an interview quote”

What do asset managers need to do tofacilitate the switch from DB to DC?
Overview
In order to reduce their mounting debts, governments on bothsides of the Atlantic are implementing a raft of policy measures,with QE as the centrepiece. They aim to stimulate growth on the
one hand and promote deleveraging on the other. Either way,
there are unintended side effects for DB as well as DC pension
plans worldwide.
Against this background, this section pursues the following
questions:• What factors will drive capital markets over the next three years?
• How will the unfolding market dynamics affect DB plans?
• What actions are asset managers taking or will they take to easethe pressure on these plans?
• How are some of the positive features of DB plans being
incorporated into DC plans?
• How is the asset industry being reshaped due to thepersonalisation of risk?
Research findings around each of these questions are presented in
the following key findings under the appropriate headings.

16

Key Findings
Market Drivers
Market drivers can be categorized into two key clusters.
The first centres on the policy action designed to reboot growthin Europe and the US. It is expected to drive up the price of risky
assets. Yet, stock markets will remain jittery because of fears thatand its hidden opportunities. That means re-vamping their risk
models in a number of crucial ways.
Furthermore, they can provide an integrated solution to asset
allocation and manager selection, since many DB plans have neither
the expertise nor the governance to cope with today’s uncertainty.

politicians on both sides of the Atlantic will yet again miss the

Finally, asset managers can make step improvements in their client

window of opportunity created by the QE programmes to adopt

engagement models, so as to convey thought leadership ideas as

the necessary reforms.

well as manage expectations on what can and can’t be delivered

The second cluster centres on ageing populations and the parallel
shift from DB to DC plans in the key pension markets. Theiroverall impact will be positive for fixed income and real assets.

in the uncertain world of deleveraging.

Upgrading DC Products
DC products have come a long way since the Pension Protection

Overall, investors can see positives on the horizon. But they

Act 2006 in the US, which designated target date funds as afear renewed volatility on account of political inaction. They

legitimate default option. Since then, the accelerated closures ofalso fear inflation on account of excessive monetary creation by

DB plans have provided further impetus.

central banks. Worst of all, they fear financial repression. The QE
programmes require exceptional foresight and luck. On their part,Some of the best features of DB plans are now being deployed

investors are being forced to lower their returns expectations andinto target date funds to ease the transition between theswitch from products to solutions, from wants to needs.

accumulation and the decumulation phases. These features
also seek to improve retirement planning by enabling members

Impact on DB Plans
The closure of DB plans will accelerate in virtually all thepension markets.
Their persistent deficits require average annual returns in excess
of 6.5% — a benchmark that has proved elusive in the past ten
years. Few hold out hopes of hitting it in the foreseeable future,
without excessive leverage or risks. DB plans will continue toto develop a better idea about their retirement needs and thecontribution rates required over the lifetime of their plans. The
result is the emergence of a single lifetime product that counters
investors’ behavioural biases and makes little demands on theirfinancial literacy.
The DC landscape is set to change beyond recognition by theend of this decade.

scale back member benefits and increase the retirement age.

Personalisation of risk

Additionally, in the private sector, DB plans will continue to use

Occurring against the backdrop of ageing populations, theunorthodox avenues to raise the funding levels as a prelude to aswitch from DB to DC plans has irrevocably put the onus ofbuyout (or transfer of the scheme’s liabilities into the insurance

retirement planning on the individual. It has also sparked twomarket). In the public sector, some will be dialling up risk, while

waves of innovation that have unleashed enduring trends, likeothers will rely on taxpayer backstops.

the course of a super tanker.

Actions by Asset Managers

One relates to LDI and one to life-cycle products. Both will

Asset managers can ease the pressure on DB plans by developing

experience powerful tailwinds over the next three years.

a deeper understanding of the debt dynamic, its hidden risk“

Real interest rates will remain low for a long time. We are in a new era in which our
expectations about growth, inflation and returns are being radically reassessed.

- an interview quote”

17

A diverse set of market drivers will pull investors in
different directions
The global economy is back on track. Equities have rallied. But theplans. The switch will also accelerate the adoption of LDI whichcrisis is not in the rear-view mirror — yet. Henceforth, a diverse

seeks to immunise all unrewarded as well as rewarded risks.

range of factors will drive markets, creating both headwinds andSecond, 53% expect funding deficits to persist in the majority

tailwinds. They fall into three clusters (Figure 3.1).

of DB plans worldwide. Those with a strong sponsor covenant
will ramp up risk; those with a weak one will dial it down. Finally,

Sovereign Debt
The first cluster centres on sovereign debt in Europe and the US.
First, 65% of the survey respondents expect markets to remain
jittery pending substantive progress on the debt front. Second,
65% expect the monetary stimulus from the QE programmes
on both sides of the Atlantic to keep boosting the markets inrisky assets. By driving interest rates down to super-low levels,the programmes are also seen as triggering a virtuous cycle that
boosts investment in houses and jobs, while making it easier forhouseholds and governments to raise funding and pay off theirdebts. In the US, for example, the Federal Reserve has also been
compensating for a tight fiscal policy by purchasing some 60%
of 10-year Treasury notes since the 2008 crisis. Finally, 57% of
respondents expect asset bubbles in the emerging markets, as
the wall of money moves from West to East in search of higher
returns. The overall impact of this cluster will be positive for

43% expect an ageing population dominated by the postWar baby boomers to affect the markets. For example, 10,000
Americans and 14,000 Europeans are now retiring every day,thereby reducing demand for risky investible assets in preference
to the ones that deliver regular income, low volatility andinflation protection. This cluster is likely to have a positive impact
on fixed income and real assets.

INTERVIEW QUOTES:“There’s a lot to worry about: everything from the US deficit
to the future of the euro to China’s economic growth.”“Corporate America has huge pent-up spending power
and wealth creation potential.”risky assets — albeit with twists and turns from periodic political“In the age of financial repression, there are no easyanswers to the problem of capital protection, only
difficult choices.”paralysis, as in the case of Cyprus in March 2013.

Demographics
The second cluster centres on demographics. First, 54% of
respondents anticipate a continuing shift from DB plans to DC

figure 3.1 	What factors would drive volatility in capital markets over the next 3 years?
Sovereign debt crisis in Europe and the US
Monetary stimulus from central banks
Asset bubbles in emerging markets
Continuing shift from DB to DC plans
Funding deficits in DB plans
Ageing populations in key pension markets
Unintended fall-out from the new financial regulation
Return to normal economic growth in emerging markets
Greater contagion susceptibility from globalisation
A strong upturn in the global economy
Further economic liberalisation in the emerging markets
0

Source: Principal Global Investors/CREATE-Research Survey 2013

18

10

20

30

40

% of respondents

50

60

70

80

65% expect the markets toremain jittery due to the debt
crisis in Europe and the US

62% expect the actions by
central banks to drive themarkets

54% expect the shift fromDB to DC to drive the markets

Regulation and Growthsequester of spending cuts in the US, and the explosive growth

The third cluster centres on three unrelated drivers, each capableof a shadow banking system in China, to name but a few.

of destabilising the markets from time to time. First, 34% of

The tail-risks will be wagging the markets. The fear of another

respondents expect unintended fall-out from the new financial

2008-style collapse has subsided. Yet, the odds of anotherregulations. Basel III will force the Western banks to hold higher

2009-style bounce remain long, for now.

sovereign debt in their core capital. Solvency II will go a step

The feel-good factor is returning. But investors are not throwing

further and force insurance companies to hold capital buffers

caution to the wind. Fear continues to lurk in the backgroundwhen investing in risky assets. The ‘Volcker Rule’ will harm

pending clarity on fiscal reforms in the West. Accordingly,

liquidity and raise costs in the less traded bonds. Second, only

different investor segments will display diverse behaviours in

25% of respondents see the emerging economies resuming their

response to the identified market drivers.

normal growth path after the big 2011 hiccup. Finally, only 22%
expect a strong global economy — traditionally a key source oftailwinds for risky assets.

INTERVIEW QUOTES:

Two recurring themes emerged in the post-survey interviews.

“The US deficit in 2013 will be 5.3% of GDP, half
the level in 2009. Prices are rising in almost half the
housing markets.”

First, the QE programmes risk exposing investors to a prolonged
era of financial repression, defined as a combination of low real
yields which erode the purchasing power of their capital slowly but
steadily while helping to vaporise public and private debt. In thepast, such repressions have lasted anywhere from 10 to 35 years.
Second, there is plenty on the horizon that can send investors
back into hiding: Europe’s fragile banking system, the so-called“Inflation rarely fools investors unless it is unexpected.
It is always discounted in interest rates.”“Expansion in P/E multiples will occur when we see concrete
improvements in the real economy and fiscal reforms.”

a view from the top...
All the dire predictions after the Lehman shock have not happened:
the Eurozone has not broken up, America has not fallen over the
fiscal cliff, China’s economy has not crash landed and the world
has not suffered an oil price spike. Markets have rallied due todisappearing worries as much as to positive news.
Decisive actions by the Fed in the US and the ECB in Europe have
prevented a bad situation from getting worse. Indeed, we may well
be turning a corner now.
In the US, the housing market, the job market and shale gas
production are bright spots. Economic growth is below the long-run
average of 3%. But fears of a double-dip recession have receded. No
wonder the Dow and S&P 500 have hit pre-crisis highs — levels thatcan only be sustained if growth accelerates or Washington delivers
the much-needed debt accord. For example, the health care system
continues to account for 18% of GDP, eight percentage points higher
than the OECD average. The US economy can surprise on the upside.
After a market slowdown in 2011, emerging economies, too, areback on track. Their current rate of 5.5% is below the past average.
But countries like China, Indonesia, Singapore and Taiwan are
moving into 7% territory. While their markets remain volatile, theirfundamentals remain structurally sound, as shown by their increased
currency reserves and low labour costs.

Europe, on the other hand, continues to muddle through with too
many air pockets. While Germany, the Netherlands and Sweden
have managed to avoid them, elsewhere the austerity programme isproving self-defeating. Spending cuts are inflicting a heavy drag on
growth, jobs and tax revenues. Europe’s will be a jagged recovery.
The potential for policy errors is big. Negatives will keep cropping up— like the Cyprus banking crisis.
The global economy, thus, will experience a two-speed recovery, with
the US and emerging markets in the fast lane and Europe in the slow
lane. But three questions will continue to dog the markets: How longcan central banks on both sides of the Atlantic keep rates so low as
to help their governments to finance their debts? Will these central
banks be able to unwind their massive balance sheets without fuelling
big rises in inflation and interest rates? Will politicians stop kicking thecan down the road and adopt coherent deficit reduction plans?
While there is reluctant acceptance that the Fed’s QE is the least
worst of all lousy options to reboot the global economy and financial
markets, its end-game remains highly unpredictable. It can help
investors. But it can hurt them, too.
				

– A global asset manager

19

The closure of DB plans worldwide will accelerate in the faceof unsustainable deficits
The combination of two bear markets and marked-to-market

20% are ‘frozen’ for current members. Even in Japan, with aaccounting rules in the last decade has progressively made DB

culture of jobs-for-life, the pace of closures has accelerated. Moreplans ruinously expensive for their sponsors.

notably, there and elsewhere, as the plans have closed, they havealso moved into low-risk assets. The closure has been confined

As we saw in Figure 2.3 in the Executive Summary, only 33% oflargely to private sector plans.

DB plans currently have a funding level in excess of 100%. In 11
major pension markets (including Canada, Ireland, Japan, theIn marked contrast, in the face of rising deficits, public sector

Netherlands, Scandinavia, the UK and the US), the deficit wasplans elsewhere in the West will continue to remain at the top

25% in 2012 compared with 4% 10 years earlier.

end of the risk curve, as we shall see in Section 4 of this report.
Apart from closures, a number of other one-off measures will

For example, companies in the S&P 500 Stock Index posted acontinue to be taken over the next three years on two fronts:

deficit of circa US$610 billion at the end of 2012, sharply up from

non-investment and investment.

US$484 billion in the previous year. Despite rising markets since
the crisis lows in 2008, many plans have gone nowhere due to theTaking them in turn, retirement age and member contribution rates

falling discount rates caused by QE in Europe and the US. Hence,

will continue to be raised by ever more plans. Benefits based onplans are now obliged to adopt unrealistically high return targets.

final year salary will be replaced by career average salary. Indexation
will become discretionary. Hardwired as they are into job contracts,

As stated in the Executive Summary, just over 50% of plans target

however, old entitlements will prove difficult to change.

over 6.5% net of fees and charges. Not only is this well above
what was achieved in the last decade, it is also optimistic when

INTERVIEW QUOTES:

set alongside the projected return of between 4% and 6% for an
average portfolio over the medium-term.
As a result, plan closures will accelerate in this decade (Figure 3.2).
63% of asset managers in the survey expect the pace to accelerate
and 23% expect it to moderate. The corresponding figures forpension plans in the survey are 56% and 30%, respectively.
Of all the OECD countries, the UK has had the fastest rate ofclosures. Only 13% of plans are now open to new entrants and“Although markets have recovered from crisis lows, pension
deficits have not improved due to low discount rates.”“The EU’s proposed Solvency II may well raise the deficits
in DB plans in Europe by nearly US$550 billion.”“The speed at which investment opportunities open
and close is accelerating.”

figure 3.2
What will happen to the pace of the switch from DB to DC plans in your jurisdiction in this decade?
asset managers

1%

1%
13%
23%

pension plans

4%
13%
23%
63%

Accelerate

20

10%

Accelerate

Moderate

63% Reverse
Not sure

Source: Principal Global Investors/CREATE-Research Survey 2013

4%
10%

Moderate

30%

30%
56%

56%

ReverseNot sure63% of asset managers
expect the closure of DBplans to accelerate

56% of pension plans expect
the closure of DB plans toaccelerate

30% of pension plans expect
the pace of closure to moderate

On the investment front, new measures are being taken tolower discount rates than the average of 7.5% used in the past 10

change the interest rate assumptions that corporate plans use foryears. In the absence of cash injections from sponsors, this will drive

calculating their liabilities. For example, in the US, instead of using

them up the risk frontier.

recent rates, sponsors will be able to use a 25-year average of rates.

Hence within the DB space, the responses to financial repression

Under federal law, this will shrink deficits for immediate funding

will vary by sector.

purposes, without reducing long-term pension obligations.

INTERVIEW QUOTES:

Furthermore, in the US and Europe, corporates will continue
issuing bonds at today’s very low rates to bridge deficits and, insome cases, become fully-funded before buying bulk annuities fortheir members. For corporate DB plans, the end-game is in sight.
Alongside LDI, plans are resorting to risk mitigation devices likelongevity insurance, bulk annuities and implemented consulting.

“Ever more plans are reviewing member benefits andretirement age.”“The median state pension plan in the US is 72% funded,
down from 83% in 2007.”Pressure is building up on public sector plans, too, notably in the“Our foundation has floated a bond so as to buy
Standard Board (GASB) in 2012, plans have to be more open about Korean won to hedge against the Japanese yen to bridge
how they calculate their future obligations and also adopt muchits deficit.”
US. Under the new rules from the Governmental Accounting

a view from the top...
An ageing population and marked-to-market rules are together

are allowed to eat into capital in periods when the returns are

hastening the demise of private sector DB plans in Japan. Largemeagre. The new reality is that no nest egg is sacrosanct while

companies are closing these plans to new members and shiftingyields remain so low. It has been forced on Japan because of ourthem to DC plans as has happened in other OECD countries

semi-permanent deflation due to bad business decisions and an

over the past 10 years. With funding levels persisting at aroundageing population.

70%, some are even offloading the so-called substitution portionof their assets and liabilities to the giant public sector plan —Government Pension Investment Fund (GPIF), as permitted by
the Daiko-Henjo ruling of the early 2000s.

Japan’s companies have yet to deliver products that could
unleash pent-up demand among the country’s rank of wealthy
retirees and pay higher wages to its shrinking and relatively poor
youth. Some US$18 trillion — roughly three times the national

Total pension assets in Japan amount to roughly US$3.5 trillion,

income — of private savings are sitting in bank accounts earningwith 97% in DB plans and the rest in DC plans. DB plans are

0.02% instead of being channelled into health care, nursing,

dominated by the public sector, which accounts for nearly 70%

tourism and leisure. A vicious cycle of contracting population andof total assets after absorbing the liabilities of many private

economic sclerosis has retarded innovation and productivity.

sector plans. It is in net draw-down phase now.

Without a growing economy, the pension promise is easy toJapan has the fastest ageing population in the world. Aroundmake but hard to keep. The promise has to be rewritten. Societal

25% are over 60. Yet, there is a dearth of retirement income

expectations need to come down. At the same time, the asset

products. The ones that are available cost too much: typicallyindustry needs to recalibrate its value proposition for retirees.

an upfront fee of 2% and a recurring fee of 1.25%. The returns

With the closure of DB plans, retirees will emerge as the biggest

are meagre. The money is invested in sovereign bonds in generalinvestor group. They have the added worry that their hard

and Japanese government bonds (JGBs) in particular. Theirearned savings will be eroded as the Bank of Japan doubles theforeign investments were hit by currency fluctuations while theamount of money in circulation over the next two years.

yen was riding high until recently. Notably, these income funds				– A Japanese Asset Manager

21

Asset managers who can find opportunities in the dynamics
of deleveraging will be the biggest winners in this decade
The deleveraging now in progress in Europe and America is part

According to the post-survey interviews, some 35% of theof a bigger narrative that extends beyond cutting the debt. When

respondents see QE as delivering inflation and not much else.

banking losses were socialised after the Lehman crisis, what started

A further 25% see it as deflationary, as the associated low

as a financial problem turned into a structural one. If growthyield encourages imprudence on the part of governments andin Europe and the US had been maintained at its average level

undermines the viability of the finance sector. The remaining 40%

between 1990 and 2007, GDP would have been some 15% higher

see it as a motor that can revive Western economies and improveby 2013, with a bigger rise in tax revenues.

the climate for sorely needed reforms in public finances.

Hence, as we saw in the Executive Summary (Figure 2.1),

Accordingly, when asked what asset managers can do to help theirgovernments are relying on a combination of five factors to drive

clients in these unusually unsettled times, the respondents’ views

the deleveraging process:fell into two neat clusters (Figure 3.3).

• Economic growth that increases revenues

Investment Capabilities• Rising inflation that increases the real value of debt

The first cluster centres on investment capabilities. First, 67%• Low interest rates that reduce the cost of servicing debt

of the respondents want asset managers to develop a deeper
understanding of the debt dynamic, its hidden risk and its hidden• Austerity that reduces government borrowing

opportunities. Second, 49% want them to provide an integrated• Reform of public finances that enables nations to live within(implemented consulting) solution to asset allocation and manager

their means

INTERVIEW QUOTES:The intent behind the QE programmes in Europe and the US is
to accelerate the pace of the first three drivers (economic growth,rising inflation and low interest rates), so as to buy time for thelast two (austerity and reform of public finances). However, all thepolitical sound and fury around the ‘fiscal cliff’ and the Euro breakup, sparked by this dynamic since its inception, has side-lined theconventional investment wisdom on risk premia, diversification
and risk-return trade-off. Investors feel stranded on shaky groundin uncharted territory. Their views on QE are divided.

“It is impossible to deliver superior performance,
unless you do something different from the rest.”“Maximum benchmark relative returns or the top ranking
in last quarter’s league tables should not be the goal.”“Risk budgeting is an idea whose time has come.
It requires a different mindset.”

figure 3.3 How can asset managers help their DB clients to cope with the consequences of complex deleveraging
and low interest rates?
Develop deeper understanding of the debt dynamic, its hidden risk and its hidden opportunities
Avoid unrealistic claims about returns
Manage expectations about what can and can’t be delivered in today’s markets
Highlight proactive buying opportunities
Provide an integrated solution on asset allocation, manager selection and investment options
Foster greater alignment of interests
Create new opportunity sets in the credit space as banks shrink their asset baseSpot value opportunities and value traps arising from market volatility
Offer second opinion on clients’ asset allocation
Stress test new products under extreme scenarios
0

Source: Principal Global Investors/CREATE-Research Survey 2013

22

10

20

30

40

% of respondents

50

60

70

67% cite a deeper
understanding of the debt
dynamic as important

61% cite avoidance of
unrealistic claims about
returns as important

55% cite managing client
expectations as important

selection, since few pension plans have the skill sets and gover-much as their own perceptions of it. Fundamental correlation willnance structures to cope in a prolonged era of volatility. This form

resume only when markets are largely driven by fundamentals.

of consulting — also known as fiduciary management — is taking

Second, to avoid the prospect of another ‘lost decade’, asset

off in Europe. Finally, 43% want them to create new opportunity

managers need to turn from distant vendors into trusted advisors

sets in the credit space, as banks shrink their balance sheets whenof their clients. In the volatile markets since 2008, many good

Basel III comes on stream.

investment products have not survived the regular panic sellingand buying. ‘Wrong time’ risk has emerged like a bolt fromManaging Client Expectations

the blue, only to be superseded by ‘regret’ risk when markets

The second cluster centres on client engagement. First, 61% wantrecovered. Investors’ herd instinct has cost them dearly.

asset managers to avoid unrealistic claims about returns.
Second, 55% want them to manage their clients’ expectations on

INTERVIEW QUOTES:

what can and can’t be delivered, while conventional investment“Asset managers have to decouple marketing from thought
leadership. Clients value impartial assessment and advice.”assumptions have been over-powered by unpredictable macro
events. Third, 51% want them to highlight proactive buying
opportunities. Finally, 48% want them to foster greater alignmentof interests via meritocratic fees and the avoidance of peer herding.

“When asset class correlations are dictated by macro factors,
risk-return numbers are observable, not exploitable.”

These clusters speak to two imperatives. First, asset managers need

“The fiduciary management market will grow at CAGR 20%
as pension plans look for rounded expertise.”classes that are highly influenced by the state of market liquidity as
to place more emphasis on dynamic correlations between asset

a view from the top...
Markets are now influenced more by ‘noise’ than ‘signal’ dueto the debt crisis. The pool of AAA-rated government paper has
contracted by 65% since 2007. There are now over 3,300 ETFs
worth $1.5 trillion of assets, not only providing huge daily liquidity
but also raising asset class correlations as trades move in tandem.
Risk models based on the notions of risk-free assets and static
correlations need a big makeover.
The 2008 global financial crisis showed all too clearly that thesemodels are over-simplified and over-trusted. They’ve relied heavily
on technology only to discover that it improved the measurement ofrisk but not our understanding of it. The models put more emphasis
on returns than risk, on short-term than long-term, on normal
distribution of returns than fat tails of returns and on marked-tomarket measures than fundamental valuations. In all, they fail tocapture two important factors that have had a disproportionate
influence on returns in the recent past.
The first is path dependency. By not looking at risk in a multi-period
context, the models ignored the fact that returns in any one period
can be heavily influenced by returns in previous periods, whenmomentum is working.
The second factor is the Heisenberg Uncertainty Principle. In
investment speak, it says that an investor’s own actions andreactions themselves introduce new risks, as do the reactions ofother investors as they weigh up each new situation. Investors haveto lower their expectations of predictability and learn to cope withmore randomness and more extreme events. It means plan less andprepare more.
Institutional investors are taking these messages on board. After the2008 crash, there was a lot of willingness to buy tail-risk hedges
with asymmetric pay-offs: for example, options, swaps and credit
default swaps. This applied to those pension plans with derisking
glide paths that exposed their funds to market risks for an extended
period. Now, they are doubtful about the pay-off. Hedges impose asignificant drag on performance.
The new pre-occupation is to secure the same protection witha risk-based diversification, in which assets are allocated on thebasis of various risk factors (e.g. credit, liquidity, duration, inflation,
equities). This is in contrast to the current practice in which assets
are allocated mostly on the basis of their historical performance,
irrespective of inherent risks. The new approach is being adopted in
all the pension markets by around 40% of pension plans. They are
creating pressures on asset managers to refine their own risk models
and move towards a regime of risk-adjusted returns that factors inrisks from a multiplicity of sources. 		
						– A Global Pension Consultancy

23

Innovations are taking the best features of DB plans into DC plans
Currently, total pension assets worldwide amount to around• First, in the face of low returns, investment approaches are

US$30 trillion. Of this, 43% is held by DC pension plans

becoming more diverse in the markets where DC plans are runcompared with 35% in 2000. With the accelerated closures ofby trustees (e.g. Australia, Brazil, Germany, Hong Kong and thethe DB plans, this proportion is expected to exceed 60% by the

Netherlands). This is driving the popularity of life-cycle investing.

end of this decade. That number has been already surpassed byAustralia (82%), Hong Kong (78%), South Africa (73%), Brazil(66%), Switzerland (61%) and the US (61%).

• Second, the main thrust of this rise is driven by target datefunds. Originating in the US, they are gaining traction in all
the pension markets, at varying speeds and in different forms.

A lethal mix of market losses, ultra-low interest rates, accounting

Recent plan innovations deploy the best features of DB plans tochanges and longer life spans has hastened the demise of DB

close the gap between the ‘to’ and ‘through’ retirement phases.

plans. Yet, attempts are being made to salvage their best featuresand incorporate them into DC plans (Figure 3.4).

Some DC plan sponsors are adopting the so-called ’9010-90’ strategy: a minimum plan participation of 90% via

In this context, the survey respondents have identified six
features: clarity on financial needs in retirement (cited by 56%),

INTERVIEW QUOTES:

higher and realistic contribution rates (51%), a seamless rollover“Instead of throwing the baby out with the bath water,
there’s a lot in DB plans that can be retained.”of assets from accumulation to decumulation phase (48%),a liability driven approach that targets a retirement income
benchmark (47%), a broad diversification that exploits risk
premia (44%) and dynamic asset allocation that exploits pricing
inefficiencies (37%).
The 2012 CREATE-Research report, ‘Market Volatility: Friend or
Foe’, highlighted two related trends.

“In the last decade, target date funds have taken off in
America, holding over US$400 billion of assets currently.”“The switch from asset accumulation to income generation
will characterise the pension markets in this decade.”figure 3.4 	Which of the positive features of DB plans can be emulated by DC plans as their share of global
pension assets continues to rise in this decade?
Realistic idea about finanical needs in the retirement phase
Higher contribution rates
A seamless rollover of assets from the accumulation to decumulation phase
LDI that targets a retirement income benchmark
A broad diversification that exploits risk premia at different phases of the market cycle
Dynamic asset allocation that exploits inefficiencies in asset pricing
Longer time horizons to exploit illiquidity premia
Protection against “fat tail” events
An independent advice infrastructure
0

10

20

30

40

% of respondents
Source: Principal Global Investors/CREATE-Research Survey 2013

24

50

60

56% cite realistic idea about
retirement needs

51% cite higher contribution
rates

48% cite a seamless rollover
between accumulation anddecumulation phases

auto-enrollment, a minimum 10% contribution rate via auto-

for example, the superannuation funds measure risk as either

escalation, and a minimum 90% of members invested in advice

performance versus peer funds or short-term variations in annual

embedded products like target date funds with a pre-set glide

returns, with little downside protection in volatile markets.

path for asset allocation. This approach seeks to enhance theUnder the new approach, some ‘supers’ are developing pathways

asset pot and offer various options on retirement.

to annuity-type solutions with greater certainty. Not achieving

Some asset managers are making a simple change in thethe retirement income goal is the key measure of risk. Thistarget date structure to provide guaranteed monthly income

approach aims to be effective for members who are completely

throughout retirement by replacing the traditional fixed income

engaged as well as those who are not at all engaged on

asset class with a pool of unallocated deferred annuities. Starting

retirement matters.

at 3% at the outset, the annuity income allocation grows to

INTERVIEW QUOTES:

around 55% nearer the target date.
Some managers are extending this approach around themore ambitious concept of target income fund, with a“Plain vanilla DC funds short-change clients; as do thetrustee-run plans based on a one-size-fits-all approach.”

number of distinctive features. First, it shifts the focus fromasset maximisation to liability matching, with a clear income
benchmark (see the box). Second, it eschews peer-hugging
and focuses on the retirement outcomes expressed in terms of“Every challenge in retirement space brings an equalmeasure of opportunity. Innovation is the key. Outcomes
are the new alpha.”

income, inflation protection, health care and bequests. Third,
it shifts the attention from short-term returns to overall lifestyleplanning with mass-personalisation of advice. In Australia,“Today, DC plans are where DB plans were 10 years ago:
focused on growing assets rather than matching liabilities.”

a view from the top...
For DC investors, there is an implicit disconnect in the brand of target
date funds. They are perceived as providing a path ‘to’ retirement
as well as ‘through’ retirement. In reality, most investors cash out
within three years after retiring, as these funds target an asset pot
instead of a retirement income. It is like an aeroplane that takes
off, crosses the ocean and finds that it has no landing gear as it get
close to its destination. This is not to detract from their worth asan accumulation device. But we’ve discovered that they also lendthemselves to innovation that enables them to incorporate a numberof desirable features of a DB plan.
Our target income fund does just that. It has a liability benchmark
expressed in terms of two outcomes that are meant to last over theretirement phase: sufficient income to maintain our clients’ standardof living and inflation protection. Typically linked to the replacement
ratio based on final year salary, the benchmark is also capable ofaccommodating health care needs and bequest aspirations.
It eschews a one-size-fits-all approach via a customised planthat integrates other known sources of retirement income likegovernment benefits, DB plan entitlements, current plan balance
and future contributions.
The underlying investment strategy has two goals: desired income
and the minimisation of risk in achieving it. The latter is achievedby allocating a sufficient portion of a client’s assets (plus futurecontributions) to an index-linked fixed income portfolio that isduration-matched as much as possible. The rest of the assets aremanaged to improve the estimated probability of achieving thedesired income goals — with a dedicated sleeve for alpha. Oncethe estimated probability exceeds a predetermined level, assets aregradually shifted from equities to fixed income.
This LDI-lite approach is one way in which the target income
approach seeks to mimic the best features of today’s DB plans.
There are others, too. It aims to provide inflation protection. It
manages the estimated risk of failure to achieve the targeted goals
and takes pre-emptive actions. It does not require members to makeinvestment choices, nor does it expect them to be engaged or possessa high degree of financial literacy. Above all, as with a car, it leaves
complexity under the bonnet.
Our target income fund has one over-riding merit. It aims to manage
savings explicitly over a life-cycle rather than a defined period. All too
often, the asset industry gets fixated on short-term or peer-based
measures of performance without due regard to how today’s assets
can be converted into tomorrow’s consumption.
				– A US Asset Manager

25Personalisation of risk faces an Everest of a task without
solutions-driven investing
In the OECD countries, governments are looking to reduce

education can help. But there is a big difference between financial

the cost of long-term retirement benefits. Employers, too, areeducation and investment education: one is about the basics ofde-risking their balance sheets by shedding volatile liabilities

good financial housekeeping, the other about a deep expertise,related to final-salary pensions. Insurance companies are pulling

acquired through training and years of practical experience.

out of the annuity markets as low rates have hit their balance
sheets. Risk is being personalised. Individuals are obliged to bear
the brunt of four key risks in retirement planning: investment,
inflation, interest rate and longevity. Countries such as Canada,
Japan and the Netherlands remain rock solid DB markets. But
even there, the winds of change are evident. Japan has started toroll back. The Netherlands, too, is restructuring (Section 4).

Unsurprisingly, when asked to single out the actions that will
minimise the identified constraints, three stood out (Figure3.5): deliver outcomes that matter to investors (57%),
implement solutions-driven investing (54%) and promote
financial education (52%).They are inter-related. Just as a
car requires its driver to acquire good basic motoring skills
without understanding what’s under the bonnet, the same

Everywhere, risk is being transferred from those who wereunable to manage it to those who are ill-equipped to manage
it. So, re-engineering the DC products is a welcome step in theright direction.
When asked what factors are likely to constrain the adoption of
positive features of DB plans into DC plans, two constraints stoodout (Figure 3.5): low financial education on the part of DC plan
members (71%); and the restrictive governance structures andinvestment approaches under which they operate (48%).
Managing the key risks across one’s working life brings with it aseries of decisions with no cut and dried answers. So, financial

INTERVIEW QUOTES:“Outliving their nest eggs is the number one concernof retirees.”“41% of retirees would like to leave an inheritance ofsome sort.”“Nearly 80% of investors are disengaged when it comesto retirement matters.”

figure 3.5 	What factors are likely to constrain the adoption of the positive features of DB plans into
	DC plans worldwide and what actions can asset managers take to minimise them?
CONSTRAINTS:
Low financial education on the part of members to make the right design choices
Restrictive governance structures and investment approaches of DC plans in different countries
Differences in their regulatory and tax frameworks
Complexity in plan design as and when new features are adopted
Rising costs associated with new product features
ACTIONS:
Deliver outcomes that matter to investors
Implement solutions-driven investing
Promote financial education via web based self-help tools and regular seminars
Deliver a value-for-money fee structure
Lobby governments to simplify and harmonise the regulatory framework
Focus on fewer product offerings to achieve economies of scale
0

10

20

30

% of respondents
Source: Principal Global Investors/CREATE-Research Survey 2013

26

40

50

60

70

80

71% see low financial
education as a constraint

57% see delivering relevant
outcomes as a solution

54% see solutions-driven
investing as an answer

with retirement planning. It requires a basic understanding ofEither way, the retirement market is stirring. Currently, the usage

investing plus the ability to ask the right questions and seek theof guaranteed annuities is limited due to their high cost in a low-

appropriate advice.

interest setting. Besides, few insurance companies anywhere havethe balance sheets to support them in a volatile market of the

In fact, the emerging demographic paradigm already relies on a

recent past. However, interest is growing in variants of the oldpowerful mix of two ingredients: embedded solution and ‘nudge’

annuities — notably in Australia. To render them more attractive,

economics. The former customises the targeted long-term goals

some promise a capital refund after a set term and some offer

into an integral product feature. The latter uses behavioural tools

inflation protection.

to affect positive outcomes: as exemplified by auto-enrollment
and auto-escalation that override investor inertia.

INTERVIEW QUOTES:

On the product side, the paradigm seeks to pinpoint the twosources of retirement income: via a new product at the pointof retirement (as in target date funds) or via an investment
option built into the retirement plan at the outset (as in target
income funds). In the first case, retirement income is acquiredby either stand-alone products like guaranteed annuities or by
non-guaranteed managed pay-outs. Similarly, in the second case,retirement income is targeted either via integrated features likeguaranteed deferred annuity or via non-guaranteed systematicwithdrawal facilities.

“Without solutions-driven investing, DC plans are on
the road to nowhere.”“Life-cycle funds will go from peripheral to mainstream
in all DC markets by 2015.”“The secret is to make a virtue of investors’ behaviouralbiases and build practical design features into DC plans.”a view from the top...
The bulging baby boomer generation is on the cusp of retirement.
Yet the majority of them only start to plan for it when they getclose to the retirement date. Not only do they leave it late, themajority also aspire to retire when they are either 60 or 65, despite
rising life expectancy. Evidence shows that only 14% of Australians
are financially ‘prepared’ for retirement and 51% are ‘somewhat
prepared.’ The remaining 35% of them are ‘unprepared.’ Only 30%
seek financial advice. Welcome to Australia, the shining beacon in
the DC world! The story is no different in other big DC markets. It’s
one of high expectations and low preparations.
Of course, better financial education can help. But there is aworld of difference between financial education and investment
education. The first is about basics like household budgets,compound interest, savings, investment and risk. The second
is about market dynamics, liability matching, asset allocation,
portfolio construction and manager selection.
In all Western societies, a lot is being done to improve financial
education. Whereas it is necessary for investors to have it, it is not
sufficient to enable them to make informed choices and delivercredible outcomes. Investing is complex and requires a degree of
proficiency far in excess of what individual DC plan members canever hope to possess. Their herd instinct is another major obstacle.
History shows that they regularly turn the conventional investment
wisdom, buy low-sell high, on its head.

The more practical alternative is to focus on making the investors’
world easier: build default options into plan design so that the donothing option is itself financially literate. The personalisation ofrisk is creating a general sense of insecurity that has not been felt
by previous generations of retirees. No wonder nearly 85% of ourmembers remain in default options.
Of course, this does not denigrate the notion of investor
empowerment. For example, the choice of opting out of theformal funds run by supers and setting up personalised savings
vehicles has taken off in Australia. These self-managed superfunds have grown by 94% in the last six years versus 45%
growth in the retirement savings sector as a whole. Self-managedsuper funds now accounts for well over 30% of the assets of thesuperannuation system and meets the needs of 20% of members.
The rest hope to muddle through.
Raising their level of financial education per se is unlikely to
improve retirement planning, in the absence of products that
embody solutions. Products with embedded advice are the way
forward. We’re at the dawn of a nascent revolution as our ageing
populations hit the peak over the next 10 years when huge chunksof assets migrate into the draw-down phase.
			– An Australian Superannuation Fund27

|

4 Pension Market Investors“

QE is a high wire act. If it is rolledback abruptly, all asset classes,
not just bonds, will suffer. If it
continues for long, inflationary
expectations will build up.

What goals, strategies and asset
classes will they pursue?

- an interview quoteworldwide are likely to pursue in the transition. It addresses two”

Overview
Section II outlined the forces that will be driving the switchfrom DB to DC plans in this decade. This section highlights
the investment approaches that both DB plans and DC plans
specific questions:• What goals, strategies and asset classes are DB plans likely toadopt over the next three years?
• What goals, strategies and asset classes are DC plans likely toadopt over the next three years?

28

Key Findings
DB PlansMore than one in three DB plans will pursue one or more offour goals. In order of importance, they are: inflation protection,
low volatility returns, capital protection and uncorrelated

Finally, as part of a broad diversification, real assets and credit will
attract bigger allocations, as will traditional indexed funds, ETFs
and smart beta.

DC Plans

absolute returns.
At least one in four DC plans is likely to pursue one or more of four
In the process, they will pursue one or more of four strategies:

goals. In order of importance, they are: capital growth, inflation

asset-liability optimisation, LDI, smart beta using non-cap weighted

protection, capital protection and consistent low volatility returns.

indices and dynamic asset allocation.
The factors driving these goals and strategies include: record
low interest rates, worries about the side effects of the QE

These will be pursued via one or more of three strategies: dynamic
asset allocation, traditional beta and smart beta.

programmes, market volatility, creeping inflation in some markets

The strategic mix also reflects two other likely trends. One is theand weak sponsor covenants.

prospective change in the legal nature of DC plans as they evolve

The investment choices in response to these factors will vary
between private and public sector plans.
In the private sector, choices will be conditioned by theinteraction of two factors: the funding levels and the strength ofsponsor covenants, such that:• Plans with good funding levels will adopt LDI glide paths
with progressive derisking• Plans with a strong sponsor covenant will re-risk and receive
cash injections to get them on to an LDI glide path
• Plans with a weak covenant will adopt cautious choices
and extend the duration of their recovery plans
In contrast, plans in the public sector are likely to dial up risk (English
speaking countries) or go cautious (the Continent and Japan).

into ‘defined ambition’ plans in some countries. The second is thesteady rise of life-cycle investing.

“”

Greed won’t go away. But it is tinged
with a dose of rationality forcedby the reality of poor performance
numbers.
- an interview quote

As a result, a diversity of asset classes will be pursued, once again
blending short-term opportunism with buy-and-hold investing.
Alongside the traditional actively managed equities and bonds,
investor demand will also include newly emerging balanced
funds and life-cycle funds.

LDI will be the end-game in the private sector and asset
maximisation in the public sector. Legacy assets will continue

This snapshot conceals an enduring dynamic now in progress,

to migrate under the umbrella of LDI in the first case and risky

as most active funds have struggled to out-perform the markets.

assets in the second. As a result, a diversity of asset classes will be

Under it, these legacy funds are migrating in two directions:pursued — some via short-term opportunism to take advantage

one is diversified growth funds; the other is life-cycle investing.

of periodic market dislocations and some via buy-and-holdIn both cases, the transition increasingly relies on traditional

investing to extract intrinsic value.

indexed funds, ETFs and smart beta. As in the DB space, so in

Demand for risky assets will co-exist alongside less risky assets.

the DC space, legacy funds will continue to transition towards
solutions-driven investing with clear end-goals, pursued via a

There is recognition that risky assets are currently expensive. They

broad palette of funds, backed by periodic rebalancing andhave benefited from valuation differences between equities andembedded risk management techniques. The early adopters arebonds more than by the underlying earnings fundamentals. Therealready on the scene. The late adopters are coming into view too.

is expectation that the latter may well improve, if the QE boosts
the Western economies in general and the US in particular.

Solutions-driven investing is coming of age.

29

Investment goals of DB investors will be influenced by theirsponsor support and funding levels
When the respondents were asked to identify the goals that DB

programmes. In particular, real interest rates may have to remainplans will pursue over the next three years, four stood out: inflation

low for a long time to enable governments to meet their debt

protection (52%), low volatility returns (42%), capital protection

obligations. Whereas plans in private and public sectors share these(41%) and uncorrelated absolute returns (34%) (Figure 4.1).

worries, their strategies will be different in the immediate future.

Similarly, when asked to identify the strategies that DB plans willIn the private sector, the interaction of two factors will have aadopt, four stood out: asset liability optimisation (66%), LDI

major impact: the level of funding — current assets as a proportion(64%), ‘smart beta’ using non-cap weighted indices (32%) anddynamic asset allocation (31%).
Post-survey interviews with pension plans drilled deeper into thesenumbers. It was clear that many of them have yet to recover

INTERVIEW QUOTES:“In 13 markets, pension liabilities have grown by 113%
since 1998, while assets have grown by 61%.”

from four blows suffered since 2008: the emergence of record“Around 45% of private sector DB plans will be immunisedby 2020, on the basis of the current profile of de-risking
exceptional volatility, injecting undue fluctuations in the balance
glide path.”
sheets of plan sponsors and their share prices; creeping inflation in
low interest rates, inflating the future value of their liabilities;some markets, reducing the real value of assets; and rising sponsor
covenant risk, undermining plan solvency.
Many plans fear that the next five years may be no different
due to the uncertainty around the unintended impact of the QE“In 2012, inflation and interest rate hedges added US$7.5 billion to our results. Credit and equities added only
US $2.2 billion.”

figure 4.1 	What goals will DB investors pursue over the next 3 years and which strategies are they likely to adopt?
GOALS:Inflation protection
Capital protection
Consistent low volatility returns
Stable cash flow
Uncorrelated absolute returns
Regular income
Capital growth
Relative returns
More liquidity
STRATEGIES:
Asset-liability optimisation
LDI
Dynamic asset allocation‘Smart beta’, using non cap-weighted indices
Ultra-safe investments
Traditional beta
High alpha0

Source: Principal Global Investors/CREATE-Research Survey 2013

30

10

20

30

% of respondents

40

50

60

70

52% will pursue inflation
protection

66% will adopt asset-liability
optimisation

64% will implement LDIof the present value of future liabilities — and the strength ofTurning to the public sector plans, few outside the Netherlands

sponsor covenant. For ease of analysis, plans are classified here intoand Scandinavia aim to adopt LDI. The plans in Canada, Ireland,

four funding groups.

the UK and the US will mostly dial up risk or extend their recovery
periods; and plans in Japan will mimic the ones in the fourthThose plans with ‘good’ funding levels (above 100%) have eithergroup. With backstops from tax payers, they will continue toadopted or will adopt LDI to fully immunise their portfolios. Theirbenchmark assets, not liabilities.

investment choices will be cautious.

The upshot is clear: first, roughly 25% of all plans will be on an LDIThose plans with ‘acceptable’ funding levels (between 91-100%)

trajectory by 2020; and second, for every one plan that dials up

fall into two camps. Ones with a strong sponsor covenant willrisk, there will be another that will dial it down.

aim for partial and progressive immunisation, after one-off cash
injections by sponsors. They will also dial up risk in their returns-

INTERVIEW QUOTES:

enhancing portfolio. In contrast, those with a weak covenant will
adopt cautious investment choices.
Similarly those plans with ‘satisfactory’ funding levels (81-90%) will

“A quarter of Fortune 500 companies have frozen their plans.
Their adoption of LDI has tripled to 60% since 2008.”

also be segmented along the same lines as the ‘acceptable’ group,with the strength of the covenant being the main differentiator.
Finally, in the fourth group, those plans with ‘poor’ funding levels(below 80%) will adopt cautious investment choices and extend
the duration of their liabilities.

“We will not do 100% LDI because we can earn moneywith money.”“Low yields can fuel equity markets. But they also appear to
discount deflationary outcomes for Western economies.”

a view from the top...
The current crisis has been the final straw for many plans in
the private sector. Their deficits have been trending up since thebeginning of the last decade. It is unlikely that a significant minority
will be able to honour their pension promise. Amongst the rest, fullimmunisation is seen as the end-game and LDI the principal means.

One is that estimating liabilities is an inexact science. Many plans
have been obliged to raise the funding targets at every trigger pointin their glide path, so as to protect against sovereign default or othercounterparty risks in their hedging portfolio. Today, nobody knows
what a fair price for the bonds of indebted nations is.

A growing number are adopting a dynamic approach that setsa glide path that targets rising funding levels, with clear trigger
points over time at which assets are progressively shifted from thegrowth portfolio to the hedging portfolio.

The other concern is about interest rates. At today’s historically
low rates, many see the next move as being upward. So thepotential adopters of LDI are obliged to sit on the side-lines.
However, just as many also fear that rates can go down andwreck their well-crafted glide paths.

The hedging portfolio covers assets that correlate to liabilities, andprovide duration, credit spread and liquidity. The growth portfolio,on the other hand, covers assets that offer liability ‘plus’ returns,
low correlation and broad diversification. The latter is increasingly
using smart beta strategies tilted towards minimum variance,
value, momentum, quality and other factor risks.
As and when the funding levels improve due to good returns from thegrowth portfolio, an asset shift is triggered into the hedge portfolio,
such that over time the latter reduces the duration curve and inflation
risk, while ensuring that liquidity needs are met as the scheme
matures. Some plans also use leverage in the hedging portfolio tospice up returns and achieve risk parity between the two portfolios.
However, there remain three concerns about the LDI approach.

The final concern is about the composition of the hedging portfolio.
In the first generation of LDI programmes in the UK, it had mainly
gilts or indexed-linked gilts. Over time, derivatives, swaps andthen swaptions were added to the mix for reasons of costs andaccuracy. But with falling yields and the Bank of England mopping
up some 75% of the indexed-linked gilts in circulation under its QE
programme, plans are obliged to move into other asset classes, likeinfrastructure, property and social housing. These may or may not
deliver inflation protection or regular cash flow. Bonds with shorter
maturity and higher credit quality are hard to find. We need othergilt-like instruments to help plans match their liabilities.
				– A UK Asset Manager

31Equities will see expansion in price/earnings multiples oncethe debt-front gets the green light
Having identified the future goals of DB plans, the respondents

event, progress on the political and economic front in the US iswent on to identify the asset classes likely to be chosen to meetseen as the vital for a sustained market recovery globally, given its

them. In so doing, they drew a distinction between those that

economic weight. The cult of equities can return at an awesome

would be targeted for short-term opportunism and those forspeed. Pension plans that aim to re-risk believe that risky assets

medium-term asset allocation (Figure 4.2).

are already crowded trades at their current valuations. They are

For opportunism, six asset classes were singled out: distressed
debt (49%), ETFs (44%), high yield bonds (42%), commodities

unlikely to be chased simply because they are the only game intown or because markets have now surpassed their 2007 peaks.

including gold (37%), small-cap equities (33%) and currency

Second, those DB investors who are eyeing distressed debt, highfunds (32%).

yield bonds and emerging market bonds believe that these will

For asset allocation, a further six were identified: global equities

INTERVIEW QUOTES:(56%), real estate (55%), traditional indexed funds (53%),
emerging market equities (52%), emerging market bonds (44%)
and alternative credit (44%).
Post-survey interviews revealed the thinking behind these numbers.
First, the QE programmes have lifted all the risky asset classes
recently in the belief that their multiplier effects will provide
a second wind. This could result in an expansion in earnings
multiples, if there is also debt accord in Europe and the US In any“The rich world’s growth will be 1% in 2013, slightly up on
2012. America will pick up solidly. But Europe will remain flat.”“There’s a better chance of being repaid by cash-richcompanies than by national governments.”“Until we see an orderly unwinding of QE, gold remains
attractive. The potential for nasty surprises is ever present.”

figure 4.2 	Which asset classes and generic products are most likely to be chosen by DB investors for short-term
opportunism and which ones are likely to be chosen for medium-term asset allocation?
Global equities
Real estate (debt and equity)
Traditional index/passives
Emerging market equities
Emerging market government bonds
Alternative credit
Infrastructure
Developed market investment grade bonds
Global equities with emerging market revenues
High income/low volatility equities
Developed market government bonds
Emerging market investment grade bonds
Private equity (including secondaries)
Hedge funds
ETFs
High yield bonds
Global tactical asset allocation products
Commodity funds (including gold)
Small cap equities
Currency funds
Distressed debt
-50

Source: Principal Global Investors/CREATE-Research Survey 2013

32

-40

-30

-20

-10

0

10

% of respondents

20

30

40

50

60

56% will invest in global
equities

55% will invest inreal estate

49% will invest in
distressed debt

remain attractive as long as rates remain low and spreads do not

and alternative credit are now viewed as ‘cross-over’ assets withnarrow further. However, emerging market bonds will attract

bond-like features and equity-like returns.

smaller flows due to recent over issuance and perceived low quality

Fifth, traditional indexed funds and ETFs will attract risingof covenants. This is in contrast to their status in the 2012 survey,

allocations, far higher than reported in our 2012 survey. Bothwhich anticipated bigger in-flows.

are seen as avenues of low-cost market exposures. Both are also

Third, the demand for real assets — especially real estate,amenable to tilts towards specific risk factors within a smart beta

infrastructure, farm land — will continue to grow, as everframework (box below).

more pension plans overtly target inflation protection in their

Finally, demand for developed market investment grade bonds

diversification. For example, some Canadian and Scandinavian plans

and government bonds will persist, due to their diversification

have raised allocations to 25%. This rising interest in real assets isbenefits or due to sponsors’ preference for cautious choices.

the single biggest change from last year’s survey. As the price of

INTERVIEW QUOTES:

inflation-linked bonds has sky-rocketed, pension plans are looking
for substitute assets in their hedging portfolios yielding 4-6%.
Fourth, alternative credit will also attract rising interest as banks
aim to beef up their tier-one capital with covered bonds and“For every five active mandates that come up for renewal,
three end up in passives or ETFs.”

sovereign bonds ahead of Basel III. Instruments such as senior“Real assets provide all-weather protection. 43% of
pension plans are now invested in them compared tocorporate debt, commercial mortgages and ‘secondaries’ in private
5% 10 years ago.”loans, collateralised loan obligations (CLO), subordinatedequities will attract growing demand. Like real assets, alternative
credit has one over-riding virtue: low correlation with traditional

equities and bonds and high single digit yields. Indeed, real assets“As plans advance in their draw-down phase, they need tochase a number of outcomes other than good returns.”

a view from the top...
Will the Fed derail the stock rally? Will it exit rapidly or gradually?
Will it sell assets or hold them to maturity? Our main worry isthat its path could easily turn what is now a stabilising factor into
a destabilising factor. Hence, we pursue two competing goals:
capital appreciation as well as capital preservation, via a broad
diversification with periodic rebalancing and multiplicity of levers.
Our guiding beliefs strike a balance between alpha and beta.
Increasingly we have resorted to beta investing by bringing it
in-house. Around 80% of our investments in equities now rely on
traditional index funds and smart beta. The cap-weighted indices are
inefficient, owing to their embedded bias towards concentration andmomentum. So, we tilt them towards factor premia like value, quality,
low volatility and momentum. We also use the risk-parity approach,which has delivered a higher Sharpe-ratio at ultra-low cost.
We seek to improve our smart beta approach indirectly via
implemented consulting. Under it, we have formed alliances withprominent specialist asset managers with a depth of expertise. We
give them go-anywhere type mandates and have monthly review
meetings in which we obtain cutting-edge market intelligence that is
fed into our smart beta offering.

premia on the one hand and short-term bargains on the other.
Within this separation, complex strategies (e.g. private equity,
hedge funds and real estate) are managed externally, while others
are managed internally via smart beta or simple passives.
Overall, our diversification seeks to achieve five distinct outcomes:
capital growth, high income, inflation protection, regular cash
flow and high liquidity. Via regular rebalancing, our returns have
improved markedly since 2008. Both over 10- or 20-year periods,
returns have averaged around 8% per year.
But the deficit has not gone away. It will probably get worse due tothe new accounting rules for calculating liabilities in the public sector
in the US.
That’s why the end-game of QE can have an important impact
on our liabilities. Another reason is that we are equity-overweightand equity markets can reverse quickly, if they lose confidence in
the Fed’s ability to achieve a safe landing. Investors are braced formarket-moving events that may potentially result in big losses or big
opportunities. A broad diversification is vital.
				– A US Public Sector Plan

In the process, we seek to strike a balance between buy-and-holdinvesting and opportunistic investing, in order to exploit illiquidity

33

The DC space will remain the focal point of innovation
Section 3 highlighted the changes now in progress towards

cannot control performance but they can control risks and costs via

implementing some of the best features of DB plans into DC plans.

advice-embedded products in the whole area of life-cycle investing

It also underlined the rising interest in advice-embedded products inthat takes into account members’ risk appetite and retirement

key markets like Australia and the US. Against that background, theaspirations. In the UK, for example, the new state-sponsored DC

survey respondents have identified the goals and strategies that DC

plans have adopted target date funds as a default option along

investors are likely to pursue over the next three years (Figure 4.3).

similar lines to the Pension Protection Act 2006 in the US.

Starting with goals, 50% cite capital growth, 33% cite inflation

Elsewhere a broad diversification is also likely to be pursued so as

protection, 31% cite capital protection and 26% cite consistent

to target inflation protection and capital protection. This is clear

low volatility returns.

INTERVIEW QUOTES:For DC investors in Australia, Hong Kong, Singapore, South
Africa and large segments of the US market, capital growth had
always featured high. Elsewhere, investors had opted for cautious
low volatility options like cash and government bonds — only
to discover their obvious downsides in today’s very low yieldenvironment. In countries like Denmark and Germany, with strong“DC plans have to diversify from the holy trinity ofequities, bonds and cash, and go into alternatives.”“Our diversified income fund is nudged towards aguaranteed coupon rate.”reliance on insurance contracts, returns have been low and costs“Trustee-based DC plans in Europe are too cautious. They
direction of life-cycle investing. Plan trustees have accepted that they protect the value of contributions without much upside.”
high. There and elsewhere, the winds of change are blowing in the

figure 4.3 	What goals will DC investors pursue over the next 3 years and which strategies are they likely to adopt?
GOALS:
Capital growth
Inflation protection
Capital protection
Consistent low volatility returns
Relative returns
Regular income
Uncorrelated absolute returns
Stable cash flowMore liquidity
STRATEGIES:
Dynamic asset allocation
Traditional beta
‘Smart beta’, using non cap-weighted indicesHigh alphaAsset-liability optimisation
Ultra-safe investments
LDI
0

10

20

30

% of respondents
Source: Principal Global Investors/CREATE-Research Survey 2013

34

40

50

60

50% cite capital growth
as a goal

30% cite inflation protection
as a goal

45% cite dynamic asset
allocation as a strategy

from the list of strategies that are likely to be pursued: dynamic

Second there is ample recognition that DC investors need an

asset allocation (45%), traditional beta (38%) and smart beta

intelligent approach to risk that can deliver better outcomes on(26%). Dynamic allocation will be targeted via discretionary andthe one hand and minimise investor foibles on the other. Advice-

non-discretionary rebalancing within vehicles such as multi-asset

embedded products in general and life-cycle funds in particular areclass funds, life-cycle funds or smart beta funds.

gaining momentum.

Post-survey interviews revealed two other points: one about thelegal framework and one about investment approaches.

INTERVIEW QUOTES:First, there is widespread acceptance that the current generation“We can’t keep the pension promise. So, we have torewrite it.”of DC plans in many countries are not fit for purpose. Yet, they are
here to stay. Over time, they may well morph into the so-called‘defined ambition’ plans: an amalgam of DB and DC that delivers amore equitable sharing of risks between employers and employees“The magical age of 65 has to go. But politicians haveto tread a minefield to change public opinion.”(box below). The Dutch are leading the way and Canada and theUK may follow suit. This is also seen as a device to slow down thedemise of DB plans. They amount to rewriting the pension promise“As markets evolve, the DC scheme will evolve intoa different animal than it is today.”by downsizing it.

a view from the top...
The Dutch pension system is held up as the strongest in theworld. Yet, this year, its pension plans are obliged to do something
unprecedented: decrease pension benefits by 0.5% -7% for millionsof retirees. The main reasons are very low discount rates due to theEuro crisis and the rising longevity of pensioners.

order to achieve this. As an aside, Canada, too, is considering a similar
option under the heading of ‘target benefits’ plan. More generally, theretirement age in the Netherlands is being raised in the state pension
scheme in 2014 and will be linked to life expectancy thereafter. Thismeasure will be adopted by other countries before long.

In 2007, our coverage ratio was over 140%, today it has sunk below
100%. Under the Pensions Act 2007, we have to discount our liabilities
by a rate that reflects market rates, which are now at their lowest in
centuries. Given the state of the economies on both sides of the Atlantic,
we do not see the rates rising over the next three years. Our pension
system, as a result, is in the midst of a big change in two respects.

The second aspect of change in the Netherlands is the introductionof the Premium Pension Institution (PPI), a fully transparent low-cost
pure DC vehicle that can be used on a cross-border basis under theEuropean Institutions for Occupational Retirement Provision directive.
As in the UK and US, it provides no guarantees. But the employer
has to exercise a duty of care towards plan participants by providing
life-cycle funds as the default option.

The introduction of ‘Defined Ambition’ pensions is one of them. It
is best described as a compromise pension that sits between a pureDB scheme and a pure DC scheme. Three versions of it are underdiscussion. The first version is a cash balance scheme under which
the employer guarantees a fixed pension pot on retirement and theemployee deals with the uncertainty of how much retirement income
the pot will buy. The second version pays a guaranteed pension
income, with the proviso that the retirement date can change, if life
expectancy rises again. The third version gives younger employees
an estimate of what their retirement income will be, with the range
being progressively narrowed on approach to retirement. All three
versions seek a compromise between DB and DC plans with risks
shared equally between employers and employees.
The first version is the one most likely to be adopted, with soft
rather than hard guarantees. The employer will ‘promise’ to target
a specific pension income based on average career salary on thecondition that the employer contribution will not have to be raised in

For an established DB plan like ours, these proposals are essential
although there are bound to be various transitional problems. If thecurrent low interest rates become a way of life, as seems likely, ourmove towards the defined ambition scheme will accelerate. This isespecially so, since the adoption of Solvency II has reduced our ability
to invest in risky assets without capital buffers. Over 75% of ourassets are already in fixed income. We’re not alone in this.
Our neighbours, Denmark and Germany, are also re-writing theirpension promise. An important new element is the move towards
life-cycle investing. Their old reliance on traditional insurance
contracts only works when yields are a lot higher than now. Ten
years ago, an average 30-year old with a 12% contribution a year
would expect a retirement income of 67% of the final salary. Now,
that has dropped to 39% of the final salary.
				– A Dutch pension plan35

DC investors will increasingly adopt new approaches while legacy
assets are gradually unwound
On the face of it, DC investors are likely to invest in a variety of

There is a gradual migration of legacy assets, as they have failed toasset classes, duly distinguishing between short-term opportunism

meet investors’ return expectations. The migration is heading inand medium-term asset allocation.

two directions with a common overlay.

The ones most likely to be used for opportunism include: ETFs

The first direction points towards balanced funds and diversified(cited by 41% of respondents), actively managed funds (31%) andgrowth funds; the second one points towards life-cycle investing,diversified growth funds (23%) (Figure 4.4). The latter deploy acovering target date funds, target income funds and target risk funds.

broad palette of assets and frequent rebalancing during different

In both directions, the overlay is provided by traditional indexedvolatility regimes.

funds and ETFs — the former in buy-and-hold strategies and the

The ones most likely to be used for asset allocation include:

latter in opportunistic forays. The use of traditional cap-weighted

balanced funds with a strong buy-and-hold orientation (62%),

indexed funds is growing and, as in DB plans, becoming an

traditional indexed funds (59%), target date funds (58%), actively

important vehicle for diversification. The use of ETFs and smart

managed equities and bonds (51%) target income retirement
funds (47%), and diversified growth funds (46%).

INTERVIEW QUOTES:In part, this seeming diversity can be explained by the usual inter-“There is a chunk of legacy assets that are being unwound.
Life-cycle investing will be the main beneficiary.”

country differences in risk appetite. For example, at one extreme
are Australia and Hong Kong with an overwhelming focus on
active equities. At the other are Germany and Switzerland with“Multi-asset class funds and diversified growth funds
have weathered the 2010-12 storm rather well.”a strong focus on insurance contracts.
But there is also a new dynamic at work here, according to“Actively managed equities and bonds are too limiting
for an ageing population.”the post-survey interviews.

figure 4.4 Which asset classes and generic products are most likely to be chosen by DC investors for
short-term opportunism and which ones are likely to be chosen for medium-term asset 		
allocation over the next 3 years?
Balanced/multi-asset class funds
Traditional indexed funds
Target date retirement funds
Actively managed equities and/or bonds
Target income retirement funds
Diversified growth funds
ETFs
Target risk retirement funds
Customised investment plans (including self-managed plans)
Guaranteed insurance contracts
-50

-40

-30

-20

-10

0

10

20

30

40

% of respondents
Opportunism
Source: Principal Global Investors/CREATE-Research Survey 201336

Asset allocation

50

60

70

62% cite balanced funds
for asset allocation

59% cite traditional indexedfunds for asset allocation

41% cite ETFs foropportunistic investing

beta, on the other hand, is nascent. Only 2.5% of DC assets

Overall, the migration is indicative of an important developmentin the US, for example, are invested in them. More and more

highlighted in Section 3: the Personalisation of Risk. It will drive

financial advisers worldwide are likely to channel assets into

the demand for advice-embedded products to the detriment ofthem such that, on various forecasts, the total ETF assets will

stand-alone funds. Now firmly established, this trend will change

top US$9.5 trillion by 2020, from the current level of US$1.7

the DC landscape by importing institutional quality asset allocation

trillion. A large part of this growth will be driven by the migration

tools that build on the best of the old to create the new. They aim

mentioned above.

to compensate for the limitations in investment expertise not only
among end-investors but also their advisors.

As in DB plans, so in DC plans, beta and lower fees are now

INTERVIEW QUOTES:

seen as the main source of returns. ETFs are, thus, seen as lowcost liquid options to source cheap beta. We shall return to theirlimitations in Section 5.
For now, it is worth pointing out that this dynamic will see
significant adaptation of the traditional active equity and bondproducts. They will be increasingly deployed within multi-asset
class products with in-built devices that permit retirement
planning. The projected adaptation will mirror the switch fromproducts to solutions.

“Traditional funds will evolve into solutions as baby
boomers near the retirement age.”“Without innovation, the DC plans face large unfunded‘shadow liabilities’ and face the same future as DB plans.”“With US$400 billion worth of assets, target date funds
account for over 10% of DC assets in the US.”a view from the top...
The Australian superannuation funds are in the midst of a majorof members’ lives with a progressive switch to cautious bonds as theychange. Under new legislation, they have to submit their proposals

approach their chosen retirement date.

on default offerings for regulatory approval. They also have to adopt
prudential standards in areas like liquidity and stress testing to bringthem in line with banks and insurance companies. They have to
publish league tables of costs that take no account of value added.
Consolidation will accelerate.
Long before these changes, however, the original ‘super’ model ofasset allocation had come under strain. Its dominant orientation
towards a 70:30 equity-bond mix worked while the Australianstock market had a prolonged bull run until the global financial
crisis (GFC) in 2008. In the face of double digit annual returns, it
didn’t matter that this one-size-fits-all approach took no account ofmembers’ risk tolerances or income aspirations in retirement.

Thus asset allocation evolves with age. Life-cycle funds have been
popular in the US where they account for nearly 30% of DC assets
and are included in 77% of plans. They are a new phenomenon inAustralia, where the corresponding figure is just under 5%. But makeno mistake, Australia will catch up with the US — if not surpass it —by the end of this decade.
In the process, life-cycle funds will also morph into a holistic product:
the two current separate phases, ‘to’ retirement and ‘through’retirement, will coalesce. The outcome will be target income funds,
similar to what is now appearing in the UK and US. The relative
returns benchmark may well be replaced by an implicit liability
benchmark for each member. We will see LDI-lite in the DC space

Since the GFC, however, returns failed to beat the cash benchmark

before long. That means taking money off the table from time-to-

until 2011. This underperformance has resulted in new approaches

time when the going gets rough.

to asset allocation. Multi-asset class funds are in the ascendancy.
Even more importantly, the spotlight has turned on life-cycle funds ingeneral and its two early variants in particular.

The upshot is simple. Our pension landscape will evolve away fromthe mechanical equity-bond allocation. The risk profile of the ageing
population is changing. There is less time to recover from big losses.

Under the first variant, members choose one of three risk profiles at

The centre of gravity is already shifting from investment return tothe outset and more or less stick to it over the lifetime of the plan:

retirement outcomes. The entrenched 70:30 equity-bond mentality

cautious and moderate and aggressive. Under the second variant,

will be history.

members invest in target date funds, with a fixed glide path for
asset allocation: starting with aggressive equities in the early years			– An Australian Pension Consultancy37

|

5 Mass Market Investors“

We’re at the dawn of arevolution in which investors
are demanding outcomes thatcut across conventional styleboxes and asset classes.

- an interview quote”

What goals, strategies and asset
classes will they pursue?
Overview
Section 4 highlighted the investment approaches of pension
investors, in the light of six forces that will drive the capital
markets over the next three years: the sovereign debt crisis, QE
programmes, asset bubbles in emerging markets, closures of DBplans, ageing populations in the key pension markets and the riseof solutions-driven investing.
This section goes on to highlight the approaches that twosegments of mass market investors are likely to pursue in responseto these market drivers. It addresses two questions:•

What goals, strategies and asset classes are retail investors likely
to adopt over the next three years?

•

What goals, strategies and asset classes are HNWI likely toadopt over the next three years?

38Key Findings
Retail Investors
Over the next five years, nearly 75% of the retail assets will beheld by baby boomers who are retirees or near retirees. The

HNWI. The inclusion of goals other than absolute returns in thelist reflects the belief that returns in the future will not be highenough to compensate for the exclusion of other goals.

retail market and the retirement market will converge rapidly.

Hence, investment strategies will blend caution with opportunism

Regular income, capital protection and low volatility options— and include high alpha, dynamic asset allocation, smart beta

will be the key goals for retail investors. These will be pursued

and ultra-safe options.

via traditional beta, ultra-safe investment options and dynamic
asset allocation that can target the stated goals within a single

Globally, the HNWI industry is expected to grow at adiversified fund. The implied caution will be underpinned bycompound annual growth rate (CAGR) of 9%, with the bulk

ageing demographics and the ‘sequence of returns’ risk.

of it coming from the new generation of entrepreneurs runningthe multinationals in emerging markets. They will invest in

Retail investors have also recognised that, when chasing

high-alpha strategies, with a strong opportunistic tilt towards

individual active funds in the past, they always lagged behind thecommodities (especially gold), currencies, hedge funds andmarket, often buying high and selling low. Now, the dawning

active funds. Exchange-traded funds will be used as a key

retirement needs are fast ushering in an era of solutions-driven

vehicle in the process.

investing, in much the same way as with DB plans and DC plans,as discussed in Section 4 of this report.
This has already shifted the emphasis from high returns to a highprobability of certainty in investment outcomes: from risk at theend of their investment horizon to risks within the horizon.
Retail investors expect the current low yield environment toremain low for a long time. They also believe that the conventionalmonetary multipliers will take a lot longer to boost the Western
economies in what is an unusual balance sheet recession.

“

Retirement used to be easy – youworked until 65, enjoyed retirement
for ten years and died. Now there’s
a 55% chance that one of thecouple will live to 90 and outlive
their savings.
- an interview quote

Risk Will Divide Retail Investors Between West and East
In the West, demand for income-focused funds will grow.
Significant innovations are in the works to deliver regular income,inflation protection and low volatility within a single fund. Yet
opportunism will not go away altogether, especially whenmomentum is working. ETFs will remain its main vehicle.
In the East, in contrast, the hunt for yield will intensify and attract
money into risky opaque vehicles, as exemplified by ‘wealthmanagement’ products or ‘trust’ products now available in the
shadow banking systems in China. Japan, however, will remain
a stand out. With memories of horrendous losses in the equity”

Their counterparts in Europe and the U.S, in contrast, will
migrate towards an LDI-lite approach whose benchmarks will
include day-to-day necessities, lifestyle needs, philanthropic
needs and estate planning.

As a result, they will increasingly adopt institutional-quality tools
for asset allocation, diversification, risk management and smart
beta. Their interest in equities will wax and wane. But interest in
three other areas will intensify: real assets, alternative credit andpassive funds in general and ETFs in particular.

market crash in 1989 still anchored in the investor psyche,Overall, this migration towards solutions-driven investing in theretail investors will continue to invest in term deposits, typicallyretail as well as the HNWI segments will rely on passives as a key

offering 0.02% return.

delivery vehicle.

High Net Worth Individuals

Growth in ETFs and smart beta will accelerate over the next three

Risk will be returning to the table, as will demands for betterways of managing it.

years to the extent that asset managers are already sounding
alarm bells on their potential systemic risks.

Uncorrelated absolute returns, capital protection, capital growth,
inflation protection and regular capital will be the key goals for

39

The ageing population is driving convergence between the retailmarket and the retirement market
When asked to identify the goals that retail investors will pursue

On the bonds side, too, an ageing population has forced

over the next three years, one in three respondents singled out five

introspection. Investing in government bonds was fine whengoals: regular income (53%), capital protection (46%), inflation

the rate was 7% and a 65-year-old could expect to live only 10

protection (42%), consistent low volatility returns (39%) andyears. This approach is a far cry from today, with yields below

capital growth (34%) (Figure 5.1).

2% and life expectancy over 80. Apart from credit risk, duration(or interest rate risk) has become a major concern with bonds ofWhen asked to identify the strategies that will be used to pursue
these goals, one in three respondents singled out three strategies:
traditional beta (48%), ultra-safe investments (48%), and dynamic
asset allocation (39%).

longer maturity and low coupon. At any rate, low rates are driving
up duration by stealth. The hunt for yield per se no longer seems
appealing. Instead, retail investors are transitioning to solutionsdriven investing (see box on the next page).

Thus, retail investors are likely to adopt cautious options, since thebulk of retail assets are held by baby boomers who have alreadyapproach enables investors to target regular income, low volatility

retired or are heading for it in this decade. In the process, there
is a complex dynamic at work, similar to the one reported for DC
investors in Section 4.
It is conditioned by their investment experiences in the last decade.
Retail investors increasingly realised that they significantly lagged
behind the market. It was not unusual for them to miss the first halfor two-thirds of a strong rally in stocks. If anything, they spent too
much time chasing hot stocks — buying high and selling low —while racking up the charges. This approach cost them dear.

figure 5.1

By blending multiple asset classes within a single offering, this

INTERVIEW QUOTES:“Individuals and governments are deleveraging. The fear of
deflation is real. Rates will stay low for a long time.”“Stocks in Europe are cheap. They are trading on fearrather than price-to-book or price-to-earnings.”“Since 1950, the average holding period of mutual funds
has dropped from 6 years to one year.”

GOALS:

What goals will retail investors
pursue over the next 3 years
and which strategies
are they likely to adopt?

Regular income
Capital protection
Inflation protection
Consistent low volatility returns
Capital growthMore liquidity
Relative returns
Stable cash flow
Uncorrelated absolute returns
STRATEGIES:
Traditional beta
Ultra-safe investments
Dynamic asset allocation‘Smart beta’, using non cap-weighted indicesHigh alpha

Source: Principal Global Investors/CREATE-Research Survey 2013

40

0

10

20

30

% of respondents

40

50

60

53% will target regularincome46% will target capital
protection

48% will deploy traditionalbeta to meet their goals

and inflation protection on approach to retirement and thereafter.

By the end of this decade, the weight of the retail money will be in

Their packaging approach targets specific objectives rather thanthe decumulation phase, as in Japan today. Thus far, the shift out

a single investment strategy. It also targets a high probability ofof equities has been marked in Europe and America. In the wakecertainty rather than high returns.

of the 2008 crash, fixed income was the main beneficiary. Now
concerns about ultra-low yield are diverting money into a new

Indeed, plans are afoot to create ETFs based on lifestyle risk —breed of diversified funds that target distinct solutions.

with distinct tilts towards healthcare, life sciences, fuel and carehomes, backed by simple hedges. Baby boomers are retreatingfrom their risk-taking mode.
Alpha is in the eye of the beholder.

INTERVIEW QUOTES:“Our society is older now than 20 years ago. Investor
interest in regular income is growing over capital gains.”

As the 2012 survey report, Market Volatility: Friend of Foe? indicated,“Our products make money by the power of compounding.
It doesn’t make investors rich overnight. But it keeps themthat is about beating the markets and solutions alpha that is aboutsatisfied.”
meeting investors’ identified needs. The balance is shifting towards
investors are increasingly distinguishing between product alphathe latter and will continue to do so, as baby boomers retreat fromtheir risk-taking mode.

“Investors want to be compensated for taking risk.
They don’t care about alpha and beta.”

a view from the top...
The 2000s will long be remembered as a ‘lost decade’, when risk
failed to generate return and conventional equity-bond investingcame under intense scrutiny. That experience sparked a revolutionthat has gained ground since the great crash of 2008. Its main
thrust is directed at solutions-driven investing, with a clear line ofsight between investment innovations and the investor needs.
Its early adopters are already visible in all segments. In the DB space,
they are switching to liability matching; in the DC space to life-cycle
investing; and in the mass market space to solutions-driven investing.
The fear of a prolonged financial repression may well create a tipping
point at which these innovations will go mainstream.
In the retail space, solutions-driven investing is appearing in a variety
of forms, each with a distinct theme. The most prominent one is newbalanced funds that target equity-like returns, with a strong focus onyield and downside protection. Notably, their risk is measured by theprobability of missing the targeted outcome, instead of the standard
deviation of returns.
This switch from generic products to niche strategies is evident in the
newly emerging array of diversified income funds. The early adopters
are baby boomers already in the retirement phase as well as thosenearing it. Such funds deploy a broad basket of assets, such as
high-yield bonds, global value securities, global real estate securities,
preferred securities, commercial mortgage-backed securities (CMBS),emerging market debt and infrastructure. They also use a call
option programme to reduce the volatility of the underlying equity
investments. In all, they target regular income and low volatility.

The over 60s are also emerging as early adopters of real assets
within a diversified investment portfolio to offer inflation protection.
These include Treasury Inflation-Protected Securities, commodities,
real estate investment trusts (REITs), infrastructure and floating rate
notes where rates are linked to prices. Higher inflation may well be aside effect of three challenges facing the US economy today: deficits,
debt and demographics. Even at a modest annual inflation rate of
3%, prices double every 23 years. Over longer time periods, suchhedges have proved especially effective.
A growing number of retail investors are also adopting alternative
investments in their diversified portfolios to deal with the so-called‘sequence of returns’ risk, arising from volatility. Average annual total
returns of a portfolio are a good indicator of performance over time.
But the sequence of returns is just as important in determining thedollar value of the portfolio. A variety of hedge fund strategies are alsofinding early adopters among those who want to hedge the tail risk.
In the West, over the next five years, nearly 75% of the retail assets
will be held by baby boomers born in the period 1945-1965. On
approach to retirement, they are switching from conventional
investing to solutions-driven investing. This migration is real, it ishappening and it is creating new opportunity sets for managers withbusiness models to capitalise on the unfolding population dynamic in
the developed as well as large parts of the emerging markets. We areseeing a Darwinian exercise in motion collapsed in time.
			– A US Asset Manager

41

Loss aversion in the West and the search for yield in the East
will characterise retail investing
In the light of the identified goals, retail investors are likely to

Alongside this steady but pronounced trend, retail investors inchoose a variety of asset classes, distinguishing between short-term

the West will continue to engage in periodic opportunism whenopportunism and medium-term asset allocation. The ones likely to be

momentum is working. Exchange-traded funds will be the principle

chosen for opportunism will include: ETFs (49%), actively managedmeans. Financial advisers in the US and parts of Europe are alreadyequities or bonds (38%) and theme funds (38%) (Figure 5.2).

marketing ETFs as an allocation product that embraces different
asset classes on the one hand and allows opportunism on the other.

The ones likely to be chosen for asset allocation will include: funds

Investors will continue to warm to them in the belief that althoughwith income focus (66%), actively managed equities or bonds

the cult of equities is not dead, it is unlikely to deliver high returns(54%), traditional indexed funds (52%), capital protection funds

without high risks. When momentum is working, investors would(50%) and ETFs (45%).

prefer to ride it out with ETFs, with daily liquidity and low costs.

Thus, caution will prevail alongside opportunism. There will be

In the East, on the other hand, the hunt for yield will intensify.

some marked regional differences between the West and the East,

Brazil, Russia, India, and China (BRIC) economies have witnessed

however, according to the post-survey interviews.

large net outflows from equity funds recently, as the MSCI BRIC

In the West, caution will remain the watchword. Ageing populations

Index has languished 37% below its 2007 peak, at a time whenwill be the key contributory factor. The demand for income-focused

the S&P 500 Index has reverted to its previous peak.

funds will grow. It has been challenging for asset managers to

INTERVIEW QUOTES:

define what guaranteed income funds mean at today’s level of yield.
However, such funds are seeing considerable innovation.

“In 2001, 53% of US households held stocks. Now it is 46%.”

A variety of asset classes are blended to deliver one or more of“Political paralysis in the West is driving away Asian investors.
They are putting their money in emerging markets.”

three key goals that retail investors are targeting within a single
fund: regular income, low volatility and inflation protection. The
resulting asset mix also deploys hedging tools to improve the“Stocks in BRICS nations have been trailing global sharesfor four straight years now.”

probability of outcomes (see page 43).

figure 5.2	Which asset classes and generic products are most likely to be chosen by retail investors
for short-term opportunism and which ones are likely to be chosen for medium-term asset
allocation over the next 3 years?
Funds with income focus
Actively managed equities and/or bonds
Traditional indexed funds
Capital protection funds
Exchange traded funds (ETFs)
Theme funds (e.g. Shari’ah, wealth management)
-50

-40

-30

-20

-10

0

10

20

30

40

% of respondents
Opportunism
Source: Principal Global Investors/CREATE-Research Survey 2013

42

Asset allocation

50

60

66% cite funds with income
focus for buy-and-hold investing

54% cite actively managed
funds for buy-and-hold investing

49% cite ETFs for opportunism

The resulting chase for yield has diverted funds into opaque

stocks only go down. The memory of losses worth $18 trillion

risky funds. The so-called wealth management products andafter the Nikkei’s prolonged downward trajectory since 1989 hastrust products in China are the best examples (see box below).

created gambling undertones around equity investing.

The demand for such funds will continue until the regions’ equity

In the absence of a strong and sustainable rally in the wake ofmarkets become less volatile. The current round of financial

the Bank of Japan’s latest intention to double the money supply,

reforms in China has the potential to transform its equity market

Japan’s retail investors will remain ultra-cautious.

(see box below).
For the near-term, however, regional differences will persist. In

INTERVIEW QUOTES:

the East, retail investors are generally bullish about their own“Wealth management products in China can be as toxic
as subprime bonds. They are not what it says on the tin.”economies. In pursuit of yield, their demand for opaque assets
will remain insatiable. In the West, retail investors are much lessbullish about their own economies. In pursuit of safety, they will
be prepared to sacrifice returns.
Within this broad assessment, Japan will remain a standout. Even
after the Nikkei’s strong rally since November 2012, there is a
generation of retail investors who have grown up convinced that

“Retail investors in Japan have not been stirred by the latest
35% leap in the Nikkei.”“Indian investors remain weary of equities. They’re chasing
yield and real assets instead.”a view from the top...
After the financial crisis in 2008, Asian investors started rechannelling their assets into emerging markets. Funds have flowed
into vehicles with a distinct local flavour: e.g. Shari’ah funds in
Malaysia and wealth management products (WMP) in China.
The latter have had explosive growth, with assets of US$2 trillion by
the end of 2012, representing 15% of total banking deposits. China
has surplus savings (almost half of GNP) but no suitable vehicles forthrift. Bank deposits offer meagre returns and stock markets remain
volatile and momentum driven.
Forming a key plank of the country’s shadow banking system,
WMPs are short-term investments that banks sell as a high-yieldalternative to low-interest term deposits. The amount of leverage
now building up in them is not supported by sufficient capital.
Regulators are duly tightening up the rules to curb their popularity.
There has been a parallel trebling in the number of mutual funds,
yet their total AUM has hardly moved since 2008. Equities are outof favour. Over the same period, however, there has been sevenfold
growth in assets in what are called trust products with the traditional
investment trust wrapper.
They invest in equities, bonds, real estate, direct loans to local
government and infrastructure projects. Unfortunately, investors do
not understand the true nature of the underlying risk and continue
to rely on implicit guarantees from questionable third parties.
Accordingly, trust products, too, are now under regulatory scrutiny.

This increased regulatory oversight is part of a major drive to open
up the capital markets and relax the currency and interest rate
regimes. The aim is to progressively promote the renminbi as areserve currency, as China goes from a net creditor to a net debtor
nation over the next decade, as it rebalances its economy fromforeign trade to domestic consumption.
In addition, the mainland Chinese stocks (A-shares) are to join
global indices over the next three years. Once A-shares are added to
the FTSE Emerging Market Index, China will account for 40% of it
and all that means for portfolio rebalancing around the globe. The
renminbi-denominated qualified foreign institutional investor (QFII)
quotas are being raised sevenfold.
Finally, the Shanghai Stock Exchange got the ball rolling bydirecting listed companies to return 30% of profits to shareholders
via dividends. The aim is to kick-start a buy-and-hold culture bychanging corporate governance practices that have long conspired
against shareholder interests.
In China, as elsewhere in Asia, funds are sold and not bought.
Investors wait for a salesman to call them with an idea. Initiatives
are now being implemented to raise the level of financial education
so as to persuade the citizens to save for the long-term. Like otherrich nations, China faces a rapidly ageing population in the 2020sdue to the delayed effects of the one-child policy.
			– A Chinese Asset Manager

43

Risk will be returning to the table in the HNWI segment
As the 2012 survey report showed, HNWI are turning into

Over the next three years, global assets in the high net worth

extra demanding investors, after suffering big losses in the last

segment are expected to grow at CAGR of 9%. Europe and the US

decade. For them, risk is returning to the table, as are demands

will remain the epicentre of the industry but its growth engines will

for new approaches to managing it. When asked to identify thebe the Middle East, Asia, Africa and Latin America, in that order.

goals that HNWI investors are likely to adopt over the next three

The bulk of this new growth will come from the new generation

years, more than one in four respondents singled out five goals:of entrepreneurs running the emerging market multinationals, in

uncorrelated absolute returns (49%), capital protection (46%),

marked contrast to the inherited wealth held in Europe and thecapital growth (42%), inflation protection (39%) and regular

US. Such entrepreneurs are more demanding, less trusting, keenincome (26%) (Figure 5.3).

to manage their own affairs and more interested in growing theirwealth. Their main goals are in uncorrelated absolute returns andNotably, this multiplicity of goals marks a major shift from theprevious surveys, which singled out high returns as the overarching

capital growth.

INTERVIEW QUOTES:

goal. This was done in the belief that high returns in themselves
can accommodate other goals, in much the same way as pension
plans had assumed until the equity bear market of 2000-2002.
What pension plans did after that debacle, HNWI have started doing
after the recent unprecedented bout of volatility — namely, liability
matching. We shall soon return to this point.

“Relative returns are dead and absolute returns have
many mothers.”“Asian ultra-rich investors are very demanding, since
they have the choice to invest in their own business.”

The strategies likely to be used in the process include: high alpha(54%), dynamic asset allocation (46%), smart beta (32%) andultra-safe investments (20%).

“Black box investing will remain out of fashion in atrendless market.”
GOALS:

figure 5.3
What goals will HNWI pursue
over the next 3 years andwhich strategies are they
likely to adopt?

Uncorrelated absolute returns
Capital protection
Capital growth
Inflation protection
Regular income
Consistent low volatility returns
Stable cash flowMore liquidity
Relative returns
STRATEGIES:
High alphaDynamic asset allocation‘Smart beta’, using non cap-weighted indices
Ultra-safe investments
Traditional beta
Asset-liability optimisation
LDI
Source: Principal Global Investors/CREATE-Research Survey 2013

0

10

20

30

% of respondents
44

40

50

60

49% will target uncorrelated
absolute returns

46% will target capital
protection

54% will target high alpha

In contrast, their counterparts in Europe and the US have adopted

Second, they will continue to distinguish between re-risking anda multiplicity of goals in the light of extreme market turbulencesmart risking: one involves dialling up risk; the other involves thein 2010-2011. These focus on basic day-to-day necessities, lifestyleinvestor’s version of the Holy Grail — getting additional alphaneeds, philanthropic aspirations and estate planning. A blend

without taking on further beta risks. For the latter, HNWI investorsof assets is used in the process, with a strong focus on real assets

in the West will increasingly rely on smart beta to deliver cheap

such as real estate and gold. They seek capital growth, regularalpha. Smart risking will remain the new mantra.

income, high liquidity, inflation protection, low volatility andcatastrophe avoidance.

INTERVIEW QUOTES:One version of this approach centres on the traditional core-“The risk-reward balance in real assets has improved
a lot, as investors have intensified their search foralternative yield.”satellite model. Buy-and-hold investing is concentrated at thecore; and opportunism at the satellites. Such pragmatism puts
heavy emphasis on risk, liquidity and transparency — all backed
by periodic forays into dislocated markets where the savagery of
periodic downturns is creating value opportunities.
HNWI investors will be emulating their institutional peers in twoother ways as well. First, their evolving diversification will seek
absolute returns that focus on risk minimisation more

“Many of our rich clients are keen to extract nuggets
from noise.”“Old style investing only works in a raging bull market.
If you can’t get stellar returns, you have to set other goals.”than return maximisation.

a view from the top...
The commercial real estate market has been polarising between
the core and the periphery. The core is capacity constrained andexpensive. The periphery is cyclical and speculative.
Dominated by niche players, the periphery covers assets that havebeen modernised recently with low occupancy, low rents or shorter
leases. Much of the opportunistic investing is centred on the periphery,
which has also been the focus of distressed selling after the credit crisis.
The yield differential between the core and the periphery has been
widening; the core command 5%-9% yield and 1-5% capital
appreciation. The corresponding figures for the periphery are 4-7%
yield and 1-3% appreciation. In both camps, the yield came down
sharply after the 2008 crisis.
Now, the core assets are seeing faster appreciation as pension plans
and sovereign wealth funds have started making their biggest everallocations in 2012. They target 5-7% returns net of fees dependingon locations. The ones that are particularly favoured are key businesscentres in America, Europe, Australia, Japan, Hong Kong andSingapore. Fees vary widely between the core and the periphery.
Investments from HNWI are mainly channelled to the periphery
where bank lending has been severely curtailed, opening up scopefor mezzanine finance. Commercial real estate is also seen as agood hedge against inflation. The yield in the core market proxies

bond yields. But the two do not go in tandem, depending on what
drives the interest rate changes. If rates rise because the economy
is recovering, then the overall return is much bigger due to capital
appreciation. If the rates rise because of currency crisis, for example,
then capital appreciation evaporates.
In our UK operations, we sell real estate as an LDI hedge asset by
exploiting a new niche: student accommodation and social housing.
These assets are acquired and then leased back over long periods— as long as 35 years, in some cases. These assets have regulartenants and regular cash flow. They are fully amortised, such that
assets revert to the previous owners at the end of the lease to avoid
the perception that owners are selling the family silver.
They are structured as open-ended funds, so they can be bought andsold in secondary markets. Currently they yield 200-600 basis points
over gilts. The rent increases are automatic, linked to inflation andcapped at 5%.
Big pension plans are earmarking their investments to specificportfolios of real estate. HNWI, on the other hand, are making
allocations via dedicated feeder funds. Commercial real estate isregaining its halo. Our net inflows are up nearly 20% since 2010.
				– A Swiss Asset Manager

45

Opportunism will divide the HNWI segment in East and West
The regional differences in the risk appetite of wealthy investors

concept of macro risks that regularly buffet all emerging markets.

are also manifested in their investment approaches, as defined by

Investors in Asia tend to polarise their investments between cash atopportunism and medium-term asset allocation.

one extreme and property, individual stocks and gold at the other.

At a global level, when asked to identify the asset classes that are

Such biases reveal a more acute challenge: the lack of a buy-and-likely to be chosen for opportunism, four stood out: ETFs (44%),hold mentality. In countries as diverse as China, India, South Korea

commodity funds including gold (44%), currency funds (35%)

and Taiwan, the average holding period for mutual funds is lessand actively managed funds (32%) (Figure 5.4).

than a year. The widely predicted transition from opportunism to

In contrast, a wider array of long only and alternative funds will betargeted for asset allocation: actively managed equities or bonds(59%), real estate, covering debt and equity (55%), balanced
funds (49%), hedge funds (47%), private equity (47%), andbuy-and-hold investing will be anything but gradual. The extreme
volatility of the local stock markets is one obstacle. The other is theloss of confidence in the markets in the West. The Madoff scandal,

INTERVIEW QUOTES:

income funds (46%).
Fund markets in Asia, Europe and America will deploy these funds
except for one notable difference: those in Asia (excluding Japan)
will be driven more by opportunism and those in the West by buyand-hold considerations.
Taking them in turn, as mentioned previously, Asian investors
chase returns, not asset classes. They prefer to make a few big
bets. The concept of diversification has yet to take root, as has the“Bond returns are almost guaranteed to be miserable
over the rest of this decade.”“Asian investors have higher return expectations
and shorter time horizons.”“Alternatives are becoming less and less alternativewith HNWI.”

figure 5.4 	Which asset classes and generic products are most likely to be chosen by HNWI for short-term 		
opportunism and which ones are likely to be chosen for medium-term asset allocation over the next 3 years?

Actively managed equities and/or bonds
Real estate
Balanced/multi-asset class funds
Hedge funds
Private equity
Funds with income focus
Traditional indexed funds
ETFs
Capital protection funds
Commodity funds (including gold)
Currency funds
-50

-40

-30

-20

-10

0

10

20

30

% of respondents
Opportunism
Source: Principal Global Investors/CREATE-Research Survey 201346

Asset allocation

40

50

60

59% will target actively managed
funds for buy-and-hold investing

55% will target real estate funds
for buy-and-hold investing

44% will target ETFs foropportunism

the MF Global debacle, the flash crash, the software error at

Finally, allocations to passives in general and ETFs in particular will

Knight Capital, and the bizarre spectacle of the Facebook IPO

increase. Under regulatory pressure, wealth managers are being

have undermined the confidence of wealthy investors in the East.

obliged to migrate from sales commissions to advice-based fees.

They feel that the game is rigged against private investors.

Migrating clients from one to the other is proving painfully slow,
as few are willing to pay for advice. In the US, ETFs have gained

In contrast, HNWI in the West are likely to spread their wings.

momentum in the advice channel. The same is happening on the

They will target a broader diversification than the traditional 60:40

Continent. In both cases, smart beta is firmly on the radar screen

equity-bond mix. Their interest in equities will wax and wane,

and is expected to remain so in the absence of big blow-ups.

in view of previous losses. But interest in three other areas will
intensify. To start with, real assets (commodities, especially gold

INTERVIEW QUOTES:

and real estate) will feature high on the agenda. Allocations tothese assets may well double from the average of 10% currently.
Similarly, allocations to credit products will double to takeadvantage of opportunities created by the withdrawal of banksfrom a distinct segment of the credit market on account of the
new capital needs under Basel III. Like pension plans, HNWI will beallocating to the resulting ‘cross-over’ assets with bond-like featuresand equity-like returns (see page 35).

“HNWI are increasingly using institutional quality tools
and approaches to diversification and dynamic investing.”“ETFs are actively traded by financial advisers and wealthmanagers. Smart beta is the flavour du jour.”“Derivatives-based ETFs worry the hell out of me. The low
quality collaterals can be a major source of risk.”a view from the top...
The rise of ETFs has been an outstanding phenomenon of the last
five years, with a CAGR of 30%. By slicing and dicing the investment
universe, they give customised choices at low cost. They are an easyroute into an asset class without having to pick individual managers
or securities. They are also seen as cash equitisation vehicles thatinvest excess money that would otherwise languish in a low interest
rate environment. ETFs are used to short the market or to hedge
and trade in an opaque manner. Although they are 10% of the sizeof the mutual fund industry, ETFs punch way above their weight byaccounting for a third of all equity trades in the US. Their popularity
outside the US is growing too. As with all investment tools, they dohave some potential downsides.
Some 96% of individual ETFs and 87% of ETF assets are highly
concentrated. They cover narrow market segments such ascommodities and emerging markets. Given the astonishing arrayof more than 3,400 ETF options available, selection is not easy.
Many are investing in the same basket of securities. They attempt tominimise idiosyncratic risk while being unaware of the systemic risk
being created. They also distort the price discovery mechanism whilejacking up correlations between different indices.
Furthermore, many of the relatively solid offerings are falling shortof expectations, once the difference between the time-weighted
returns reported by the ETF providers and the dollar-weighted returns
actually earned by investors is factored in.

For example, in a sample of narrowly focused ETFs, over a five-year
period, the reported returns were 21.3%; the earned ones were0.8%. The corresponding numbers in a sample of broad-based
ETFS were -4.8% and -10.8%. As ever, timing of investing makes
the difference. As more data are available over time, we will havea better idea about the actual gap between these two measures.
Finally, synthetic ETFs — prominent in Europe — carry counter-party
risks. They do not own assets like shares and bonds as collateral.
Instead, they rely on derivatives from investment banks to deliver
the benchmark return, such that the investor faces the risk that thebank may not be able to pay up. These concerns point to potential
limitations. But they do not detract from the merits of ETFs. Indeed,
we anticipate double digit growth with the emergence of active
ETFs. Their ability to pursue specific themes make them an ideal
retirement product that can target regular income, low volatility andinflation protection, as retail investors and DC investors increasingly
migrate into the solutions-driven space.
The new wall of money flowing into traditional index funds as well as
ETFs carries concentration and momentum risks. Ironically, it will also
be creating pools of underpriced assets excluded from the indices for
active managers to exploit.
				– A French Asset Manager

47

Other publications from CREATE-Research
The following reports and numerous articles and papers on the emerging trends in global investments are available freeat www.create-research.co.uk.
•

Market Volatility: Friend or Foe? (2012)• Tomorrow’s products for tomorrow’s clients (2006)•

Innovation in the Age of Volatility (2012)••

The Death of Common Sense: How Elegant Theories

Comply and prosper: A risk-based approach to regulation(2006)

Contributed to the 2008 Market Collapse? (2012)•

Hedge funds: a catalyst reshaping global investment (2005)•

Investment Innovations: Raising the Bar (2011)•

Raising the performance bar (2004)•

Exploiting Uncertainty in Investment Markets (2010)•

Revolutionary shifts, evolutionary responses (2003)•

Future of Investments: the next move? (2009)•

Harnessing creativity to improve the bottom line (2001)•

DB & DC plans: Strengthening their delivery (2008)•

Tomorrow’s organisation: new mindsets, new skills (2001)• Global fund distribution: Bridging new frontiers (2008)•

Fund management: new skills for a new age (2000)

Globalisation of Funds: Challenges and Opportunities•

Good practices in knowledge creation and exchange (1999)•

Competing through skills (1999)•

Leading People (1996)•(2007)•

Convergence and divergence between alternatives andlong only funds (2007)•

Towards enhanced business governance (2006)

Contact Details:

Prof. Amin Rajan
amin.rajan@create-research.co.uk
Telephone: +44 (0) 1892 52 67 57
Mobile/Cell: +44 (0) 7703 44 47 70

48

As with previous reports in the Principal Global Investors/CREATE-Research annual series, our researchrelied on a global survey bolstered by structured interviews.
Over 700 asset managers, pension plans, pension consultants, fund distributors and fund administratorsfrom 29 countries participated in the survey, with total assets under management (AUM) of US$27.4 trillion.
The survey was followed by 100 interviews with senior executives from a cross-section of survey respondents.
All the data presented in the report emanate from either the survey or the interviews.

Survey participants by geography and size of AUM
Australia

India

Singapore

Austria

Ireland

South Africa

Belgium

ItalySouth Korea

Canada

Japan

Spain

China

KuwaitSwedenDenmark

Luxembourg

Switzerland

Finland

Malaysia

TaiwanFranceNetherlands

UK

Germany

NorwayUS

Hong Kong

Saudi Arabia

AUM (US $ trillion)

27.4

Source: Principal Global Investors/CREATE-Research Survey 2013

Author: Prof. Amin Rajan
First published in 2013 by:
CREATE-Research
Vauxhall Lane
Tunbridge Wells TN4 0XD
United Kingdom
Telephone: +44 1892 526 757
Email: amin.rajan@create-research.co.uk© CREATE Limited, 2013
All rights reserved. This report may not be lent, hired out or otherwise disposed of by way of trade in any form,
binding or cover other than in which it is published, without prior consent of the author.

Investing in a
debt-fuelLed world

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For more information please contact: 1-800-533-1390 or principalglobal.com.
CREATE-Research is an independent think tank specialising in strategic change and the newly emerging businessmodels in global asset management. It undertakes major research assignments from prominent financial
institutions and global companies. It works closely with senior decision makers in reputable organisations acrossEurope and the US. Its work is disseminated through high profile reports and events which attract wide attention
in the media. Further information can be found at www.create-research.co.uk.