Asia-pacific Investors Seek Balance Between Risk and Responsibility

Picture credit:Eastimages/Shutterstock.com. China National Olympic Stadium, AKA the Bird’s Nest, Beijing, China.

CHANGES ON THE INSTITUTIONAL INVESTMENT HORIZON:Asia-Pacifi c investors seek balance between risk and responsibility

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© The Economist Intelligence Unit Limited 2017

Changes on the institutional investment horizon: Asia-Pacific investors seek balance between risk and responsibility

Introduction 1

About the research 2

Key takeaways 3

Near and far horizons 4

The effect of the hunt for yield 4

Eyes still on the long-term prize 5

Reputation and responsibility 6

Managing risks and changing styles 8

Passive money and the curse of correlation 8

Daring to find difference 9

Looking to new products, new markets 10

Boxout: Rolling with regulation 12

Seeking a sustainable future 13

A rising tide 13

Navigating a new world of esg investment 14

Appendix 15

Contents

1

2

3



Investors are confronted with difficult decisions and adverse circumstances as a matter of course. But in the current environment, Asia-Pacific institutional investors seem deserving of particular sympathy. Like their peers elsewhere, they are struggling to balance long-term liabilities with the need to secure yield in a world where it is increasingly scarce, which almost inevitably opens the door to greater volatility and risks. And as elsewhere, the rising tide of local and global regulation, coupled with the increasing prevalence of sustainability mandates and environmental, social and governance (ESG) targets, is piling complexity onto this process.

But Asian institutional investors are also contending with unique challenges. Their home region is the world’s fastest-growing, presenting no shortage of opportunities but also no shortage of risks that could cloud a long-term investment approach – from China’s growing debt burden to competing territorial claims in the South China Sea and an increasingly bellicose North Korea.

Many of the region’s largest economies, including China, South Korea and Japan, are aging rapidly, threatening the future viability of pension systems and putting additional pressure on pension funds and insurers to boost returns. In China, for example, the working-age population is forecast to fall by nearly one-quarter by 2050. Climate change is also forecast to hit Asia particularly hard, with the Asian Development

Bank recently warning of potentially severe impacts on economies, infrastructure and agriculture. Of the 20 major cities set to bear the brunt of global flood-related losses, expected to reach US$52bn annually by 2050, 13 are in Asia.1

All this leaves Asia’s institutional investors with the unenviable task of reconciling competing and sometimes contradictory objectives, simultaneously factoring in current trends and long-term possibilities, all while being subject to the scrutiny of regulators, stakeholders and, in many cases, the general public. How Asian investors approach this delicate juggling act, and how it is shaping their future strategies, is the subject of this paper.

Introduction

© The Economist Intelligence Unit Limited 2017 2


In June-July 2017, the EIU surveyed 571 institutional investors around the world. The research, which is a part of the Changes on the institutional

investment horizon programme sponsored by Franklin Templeton Investments, explored how investors around the world are adapting to changing fundamentals and risks, the effect on the investment time horizons and asset allocations, and the impact on long-term objectives.

In Asia-Pacific, the survey included 200 respondents. Of these institutional investors, 56 are from commercial banks, 52 from insurance companies, 41 from pension funds, 30 from endowment funds, and 21 from corporate treasury funds. 73 are large, in that their assets under management (AUM) exceed US$5bn. The remaining 127 investors have AUM of between $1bn - $5bn.

Among the respondents, 96 are c-suite executives, and the remaining 104 are non- c-suite Senior executives.

We would like to thank the following individuals who lent their time and perspectives in interviews. They are in order of their surnames:

Paul Carrett, CIO, FWD Insurance Liu Chunyen, group CIO, AIA Paul Ewing-Chow, associate director, Public

Affairs, Temasek Boris Moutier, regional CIO, AXA Asia John Woods, CIO, Asia-Pacific, Credit Suisse Heman Wong, former executive director,

Hospital Authority Provident Fund Scheme

About the research



In Asia-Pacific, a prolonged low-yield

environment and evolving regulatory landscape

have prompted many institutional investors to

take more short-term actions in a hunt for yield.

Thirty percent of those surveyed say they are more actively managing their investments, 45% say they have reallocated asset classes due to regulations, and 52% are increasing portfolio turnover despite increased riskiness.

However, the short-term search for higher returns

stands in seeming contradiction to Asia-Pacific

investors’ approach towards their return targets in

the current investment environment. Only 26% say immediate pressures have prompted them to adopt a short-term approach to setting return targets, while 39% say these pressures have actually made them more focused on long-term objectives. This places many Asia-Pacific institutional investors in a delicate balancing act between strategizing for long-term growth and trying to capture returns that come into the market on a short-term basis.

Asia-Pacific investors see market volatility as

the number one barrier to lengthening their

investment horizon; other top five reasons include

reputational risk, short-term requirements, the

global economic outlook and regulatory change.

As a result of these fears, in portfolio monitoring 28% of respondents say they are more focused on their fiduciary obligations and 27% say they are more focused on their principles and social/objectives before prioritizing long-term performance. This also highlights the reality that many regional investors, particularly sovereign wealth and pension funds, have explicit political

and social benchmarks along with long-term performance goals.

In managing their risks, Asia-Pacific investors are

particularly concerned with non-financial (for

example, geopolitical) risks and correlation risks,

which are leading them to seek diversification

across international markets, particularly those in

their own backyard. Being already well-versed in their region, 56% of Asia-Pacific investors say they are more likely to increase portfolio allocations to high-growth Asian markets such as China and India. A smaller percentage, 32%, say they are planning to diversify outside the region to manage risks.

Asia-Pacific investors are also increasingly

seeking alpha and diversification benefits in

alternative assets and new products. For 42% of respondents, the increasing use of alternative investments such as private equity, private debt, commodities and real estate is one of the top two ways to manage risk, second only to risk budgeting. Others are exploring diverse, uncorrelated assets from infrastructure to forestry. More use is also being made of derivative products as a means to both hedge risks and enhance yield.

Focus on environmental, social and governance

(ESG) investment principles or targets is a rising

regional trend. Almost two-thirds of investors polled (62%) expect to increase exposure to ESG or principle-based investments over the next three years, and 22% expect to boost exposure in the next 12 months.

Key takeaways



The effect of the hunt for yield

With interest rates and yields on institutional investment mainstays, particularly developed-market government bonds, near historic lows, many investors have been forced to adjust their strategies and look farther afield to eke out returns – often taking on more risks in the process. The Organisation for Economic Co-operation and Development (OECD) has warned of an “excessive” hunt for yield heightening insolvency risks for pension funds and life insurers as they struggle to meet the commitments made to beneficiaries or policyholders when financial markets were broadly capable of producing better returns.2

“The return target tends to reflect the risk free rate [RFR], whatever that might be,” says John Woods, CIO Asia-Pacific at Credit Suisse. “If the RFR is 5%, then investors tend to want the RFR plus a spread. If the RFR is 0%, then that influences the target. Ten to 15 years ago investors wanted 15%, now they want 3% and they would be happy with

2%. Anybody who wants 15% now will have to go to a casino.”

Asian institutional investors aren’t heading for the roulette wheel, but research has shown they have tended to adopt a shorter-term outlook and adjust portfolios more frequently than those in other regions. Our survey indicates the search for yield is likely to exacerbate this tendency.

A majority (52%) of Asia-Pacific respondents say they are taking more short-term actions such as increasing portfolio turnover to find yield, despite the increased risk such actions entail. Nearly one-quarter (24%) say they are doing so frequently, versus 21% in North America and 17% in Europe, the Middle East and Africa (EMEA). A significant proportion (40%) also say they have adjusted their average holding periods to be much or somewhat shorter in response to low yields, worsening demographics in developed markets and the pressure to generate alpha, or returns in excess of benchmarks.

Near and far horizons 1

Asia-Pacific institutional investors increasing short-term actions% respondents

Asia-Pacific institutional investors adjusting holding periods% respondents

42

35

33

32

31

13

13

Increasing short-term actions 52Not taking short-term actions 47Don't know 1

Shortened average holding periods 40Have not adjusted average holding period 42Lengthened average holding period 15Don't know 4



50%

40%

30%

20%

10%

0%

Australia China Hong Kong Japan Malaysia Singapore Thailand

2015

2050

Asia-Pacific's Ageing Population % of people aged 60 or over

Source: UN World Population Ageing 2015

“The need for yield has been a slow burn and we have seen investors going down the credit curve,” says Paul Carrett, group CIO at FWD Insurance. “Short-term it doesn’t seem so dramatic, but if you look at it over a longer point of view it’s been pretty dramatic. And we could see a dramatic reaction at some point when we have a crisis.”

Eyes still on the long-term prize

Standing in apparent contradiction to this behaviour is the increasing weight placed on long-term goals. Only around one-quarter (26%) of respondents say immediate pressures have prompted them to adopt a shorter-term approach to setting return targets, and 29% that their process for determining return targets has not changed. Furthermore, 39% say these pressures have actually made them more focused on long-term objectives.

For insurance companies the strategic focus might be on long-term growth for policyholders and shareholders, but as Liu Chunyen, group CIO at AIA, explains, “This is not to say that we don’t take short-term opportunities to increase yield… We’re aiming for long strategy, longer-term investment horizon, longer-term assets, but we will increasingly look at more opportunities that come into the market on a short-term, technical basis.”

It is a delicate balancing act. For those with lengthening liabilities, like pension funds, short-term volatility or adverse market conditions highlight the difficulty of achieving future targets, particularly in markets where demographic trends could call the very existence of such funds into question.

In Japan, for example, more than one in four people was aged 65 or over in 2015 but by 2036 one in three will be. This will challenge “pay as you go” pension funds that will have to support a rising number of retirees with contributions from a shrinking workforce – a gap that even the best strategies to maximise investment returns will struggle to address. There are currently 2.3 working-age Japanese for every retiree, but this will decline to 1.3 by 2065.

Not surprisingly, 55% of Japanese survey respondents say they have increased their focus on longer-term objectives, the highest rate in the region. The demographic issue is, however, virtually an Asia-wide one; Hong Kong will shed over half a million workers by 2064, and in Thailand the working age population’s share of the total will shrink by 11% to 2040 – the steepest decline in developing Asia.

The need, then, to lengthen investment horizons to match lengthening liabilities is vital and generally understood, but near-term concerns often stand in the way. When asked to identify the biggest barrier to this process, the highest proportion (35%) of Asian institutional investors cite market volatility which is also the top pick among investors in North America and EMEA.

This may seem counterintuitive with the Chicago Board Option Exchange’s Volatility Index (VIX)—a global market volatility benchmark—plumbing historic lows, but there are ample indications that investors across the world expect volatility to rise. In Asia, too, there is no shortage of memories of relatively recent market shocks, from the “taper tantrum” in 2013 when the US Fed hinted at unwinding quantitative easing, to



Market volatility

Reputational risk

Short-term requirements

Global economic outlook

Regulatory change

Lack of staff incentives

Governance rules

Media influence on decision makers

Silos within the organisation

Barriers to longer investment horizons% respondents, with two choices

35

29

27

27

23

17

15

15

14

China’s dizzying stock market plunge in 2015, to the descent of the Malaysian ringgit in 2017 to lows not seen since the Asian financial crisis. The challenge for institutions making for a distant shore is to contend with the waves they will encounter en route.

“We are fully conscious that with a portfolio largely comprised of listed assets, we are not immune to short-term market volatility,” Paul Ewing-Chow, associate director for public affairs at Temasek, Singapore’s S$275bn (US$200bn) sovereign wealth fund, wrote in an email interview. That said, “[G]iven we own our assets – as opposed to being a fund manager on behalf of the government – we don’t have redemption obligations, and have full flexibility to buy, sell or hold assets over longer-term horizons, to deliver returns over our risk-adjusted cost of capital.”

Reputation and responsibility

Asia-Pacific investors also identify reputational risk as the second biggest impediment to extending their investment horizon, picked by 29% of those surveyed. This compares to 26% in EMEA and just 20% in North America, indicating Asian fiduciaries may be more sensitive to government or public opprobrium for performance or administrative lapses.

This sensitivity may exist for good reason, as there are multiple recent, relatively high-profile examples of institutional investors coming under the microscope. In South Korea, insiders at the massive National Pension Service, the world’s third-largest pension fund with US$497bn of assets under management (AUM), have pointed to parliamentary audits and political interference

blunting its ability to generate returns. Australian superannuation funds and insurers have come under fire over potential conflicts of interest and alleged reluctance to pay out claims. In China, regulators have targeted the insurance industry over its allegedly aggressive investment strategy and warned of potential reputational damage.

Similarly, in portfolio monitoring, Asian investors seem more focused on their fiduciary obligations and social benchmarks than long-term performance. Fiduciary responsibility (28%) and principles/social objectives (27%) are the top two factors driving portfolio monitoring in the survey, followed by long-term performance. This is similar to the breakdown in EMEA but not North America, where long-term performance comes marginally ahead of principles and social objectives.

This highlights the reality that many regional investors, particularly sovereign wealth and pension funds, have explicit political or societal—in addition to long-term investment—goals. China Investment Corporation’s main pledges, for example, include “preserv[ing] and increas[ing] the value of state-owned financial assets”,3 while Khazanah Nasional, the Malaysian government’s sovereign wealth fund, plays a “catalytic role in driving various strategic industries and national initiatives”.4

Along with short-term market developments, these principles have the potential to complicate the formulation of long-term investment strategies. And achieving social mandates is unlikely to absolve institutions of the need to boost returns to meet future obligations, underlining again the web of interests investors must navigate as they make decisions and manage portfolios.



Portfolio monitoring drivers% respondents

42

35

33

32

31

13

13

Fiduciary responsibility 28Short-term performance 17Long-term performance 21Principles / social objectives 27Reputational risk 9

“Pension funds need to think more from the angle of the beneficiaries,” says Heman Wong, former executive director at Hospital Authority Provident Fund Scheme in Hong Kong. “They need to be careful that they don’t do only what they are supposed to – if members are unhappy, this can be very damaging.

“This is particularly something that needs to be addressed in Asia where some of the pension funds have grown very big too quickly. There is a big knowledge gap as the region does not yet have enough investment professionals.”



Managing risks and changing styles 2

As investors juggle at times competing goals and adjust portfolios or styles more frequently, the risk picture has changed significantly for many. No longer can institutions simply park most of their funds in relatively stable government bonds and expect solid returns to meet their liabilities decades ahead; portfolios are now more typically spread across a broader range of assets that carry various risk exposures and duration profiles. This has increased worries about risk and redoubled the industry’s emphasis on risk management.

In the Asia-Pacific region, financial stability risks and the economic cycle are the main worries of institutional investors, picked as the top two concerns by 43% and 40% of survey respondents respectively. This again points to heightened awareness of the possibility of short-term market developments—such as another sudden currency devaluation in China, or a dip back into deflation in Japan—derailing strategies and long-term investment goals formulated for times of relative stability.

Risk concerns in Asia also have a more pronounced geopolitical dimension given potential flashpoints such as the Korean Peninsula and the South China Sea, and trade-related and other warnings directed at countries like China from the Trump administration. Non-financial (for example, geopolitical) risks are cited as one of the top two biggest risks to achieving long-term investment targets, selected by 47% of Asian investors. This view is shared in EMEA but not in North America, where institutional investors are more concerned about short-term volatility and liquidity.

Passive money and the curse of correlation

Asia-Pacific and EMEA investors also agree that correlation risk is the other main threat, with 50% and 58% respectively placing it in the top two risks to long-term investment goals, versus just 40% in North America. In essence, this is the fear that due to close correlation between the various assets in a portfolio, adverse events can cause significant losses across all of them.

Financial stability risks

The economic cycle

Mispricing of risk

Market volatility

Portfolio diversification

Geopolitical uncertainty

Corporate governance

Inflation

Current concerns of institutional investors% respondents, with two choices

43

40

30

27

21

17

15

8



Diversification—that is seeking assets that are not correlated (or are negatively correlated) so that a single event or trend doesn’t devastate the whole basket—reduces portfolio risk. But diversification has become more elusive. The globalisation of financial markets, an extended period of massive liquidity from central banks, and the hunt for yield have resulted in a flood of cash into a wide range of assets, breaking down traditional correlation patterns. Even stocks and bonds, which historically tended to move in opposite directions, have more recently been moving in tandem.

The exponential growth of passive funds, particularly in the US, where passive investments are expected to account for over half of assets under management in the next four to seven years, has been blamed for exacerbating correlation and further challenging diversification.

“If you look at it from the perspective of long-term investors such as ourselves, we do worry at a systematic level and whether there are enough people making an active decision about what the value of a company is,” says Mr Carrett. “Investors disagree and they argue; capitalism can be messy and it’s not perfect but that’s what makes the market – when you have buyers and sellers. If you don’t have enough people deciding the value of a company, at a fundamental level things can be mispriced for a longer period of time. You can have a sheer wall of money pushing a stock price in one direction, and that means as an active investor you have to hold your position for longer.”

The end result is that effective risk mitigation and portfolio management are far more difficult. Diversification is no longer what it used to be, and the traditional stock-bond mix may no longer be enough to create a truly diversified portfolio. This has prompted institutional investors to explore farther—and at times riskier—territory.

Daring to find difference

With true diversification increasingly found only beyond standard stock and bond markets, Asian institutional investors have more appetite for alternative assets that have more potential to reduce portfolio correlation and generate the higher returns needed to meet long-term targets. A 2016 report from consultancy Cerulli Associates noted a decline in the number of traditional investment mandates issued by Asian institutions, while demand for alternative investment

strategies had increased markedly, particularly in China, South Korea and Hong Kong. Some South Korean institutions, the report noted, are targeting to invest at least 20% of their portfolios in alternatives before 2020.5

In our survey, 42% of Asian respondents name increasing use of alternative investments such as private equity, private debt, commodities and real estate as one of the top two ways to manage risk, second only to risk budgeting (46%). More institutions are investing directly in private firms. Singapore’s GIC, for example, has snapped up stakes in an unlisted Philippines food producer and a Brazilian online sports retailer; along with Temasek and Malaysia’s Khazanah, it is among the largest global sovereign fund investors in the tech sector.

Others, alone or as part of consortia, are exploring diverse, uncorrelated assets from infrastructure to forestry. Even Japan’s famously conservative Government Pension Investment Fund (GPIF) is getting in on the act; it is aiming to invest up to 5% of its portfolio in alternatives and recently put out a call for private equity, infrastructure and real estate investment managers.

Investors interviewed for this paper are also steadily exploring new products and asset classes that are gaining traction in the region. “If you look at the banks, they have been deleveraging their portfolios,” says Mr Carrett of FWD. “Especially in Europe, banks have been implicitly selling portfolios of private loans to investors like us and that’s somewhere where we can get involved. And of course we do have private equity, but with so much money going into it the broader market will struggle, so you have to spend more time picking the right managers and opportunities.”

Certainly, investments like these suit a longer investment horizon and a willingness to tolerate greater liquidity risk. Though for institutional investors there is a reduced need for immediate liquidity, they still need to be compensated for committing assets over the long-term, Mr Woods says. “In private equity investors are more willing to be locked up for four to five years, but they need to be compensated for this by returns. No investor is willing to be locked up for five years for a 3% return.”

The drive for diversification, as well as concerns about correlation, financial and political risks, may be behind an Asian institutions’ apparent aversion to passive investment. Just 27% of those



polled in Asia-Pacific said they adopted a mostly or entirely passive investment approach, versus 30% in EMEA and 52% in North America.

Looking to new products, new markets

Asian investors also seem to see more diversification opportunities emerging in the future. Asked to identify the top opportunities for alpha creation over the next three to five years, the top two responses were the development of new products (48%) and the opening of new markets (38%). The latter was perceived as the top opportunity in North America and EMEA as well, selected by 52% and 54% of investors in in the two regions respectively.

This likely reflects a couple of key regional differences: one is that Asia-Pacific investors are more comfortable at home while investors elsewhere may still see Asia as a largely untapped market. Asia-Pacific investors seem already well-versed in their own backyard; 56% say they are more likely to increase portfolio allocations to high-growth Asian markets such as China and India, while only 32% say they are planning to diversify outside the region to manage risks.

“In terms of diversification, for Asian entities the first action is typically to go offshore to the extent that regulations allow,” says Boris Moutier, regional CIO at insurer AXA Asia. “For many Asia-based investors, the Asian market is a natural first step for diversification. But we believe, especially for fixed income, if you want to access broader investment opportunities, you should go for global emerging markets beyond Asia. Within our strategic asset allocation, we have diversified the credit bucket with global emerging market bonds, in addition to domestic Asian corporate bonds.”

Another difference is that in Asia there is more room for growth in investment products, particularly in closed markets such as China. Due to a combination of market forces and regulatory reluctance many products—active and passive—have been slow to gain traction in the region. By mid-2015 Asia accounted for less than 8% of hedge fund AUM, for example, and leveraged/inverse ETFs were only approved in Hong Kong last year. No Asian market has yet approved the distribution of actively managed ETFs.

This leaves room to grow, and more use is being made of derivative products as a means both to

Risk budgeting

Increasing use of alternative investments

Currency hedging

Diversification of traditional asset classes

Hedging with options

Volatility hedging

Managing portfolio risks% respondents, with two choices

46

42

40

33

30

11

New products

New markets

Increased focus on factors

Regulation arbitrage opportunities

New/advanced technology solutions/tools

Limited opportunities

Don’t know

Opportunities for alpha creation over the next 3-5 years % respondents, with two choices

48

38

36

34

23

10

1



hedge risks and enhance yield. “Not all markets in Asia are equipped with efficient derivative markets but hedging with derivatives is typically a strategy we use to mitigate volatility,” says Mr Moutier. “We also use them for yield enhancement to efficiently replicate the returns of a cash asset. For example, credit default swaps are used to gain credit exposure akin to corporate bonds.”

Mr Carrett of FWD agrees: “Derivatives are one area where we can be thoughtful and make money.”

In the near future, burgeoning demand and the region’s continued robust growth will also

continue to broaden the pool of products linked to alternative assets. Take infrastructure: the Asian Development Bank estimates Asia’s infrastructure needs will reach US$26 trillion through 2030,6 much of which will be funded through private sources, presenting a significant opportunity to achieve low correlations and long-term returns. Innovations in ESG investment are also emerging in markets like Australia, a leader in green and social debt issuance, to meet rising demand for sustainable assets – a phenomenon explored in the next section.



Impact of regulatory change% respondents, two choices

Provisions for post trade compliance

Provisions for investor protection covering the entire lifecycle of investment products and services

Provisions for pre and post trade transparency

Provisions for internal risk review

Provision of policies to supervise new technology/technological disruptors

Don't know

57

53

50

27

13

1

The increasing emphasis on regulation at the global level and the pace of change in the region’s diverse patchwork of regulatory regimes make it no surprise that regulation is reshaping the investment process. Asian institutional investors see regulation having the biggest effect on provisions for post-trade compliance (selected by 57% as one of the top two areas being impacted by regulation) and provisions for investor protection covering the entire lifecycle of products and services (53%).

This emphasis is likely to increase further given recent regulatory activity in this area. Hong Kong, for example, has launched consultations on enhancements to financial dispute resolution practices that will significantly boost the ability of investors to make claims, while Singapore recently strengthened safeguards for retail investors.

The biggest short-term headache associated with regulation for Asian institutional investors is mitigating compliance issues, chosen as a concern by 51% of those surveyed. This is in line with research showing that compliance is demanding a greater portion of institutions’ financial, technological and human resources. A recent study in Japan, for example, showed fund managers

typically allocate up to 10% of total expenses to regulatory compliance and that most expect this amount to rise further.7

Mispricing of risk is the second most immediate regulation-related concern, chosen by 48% of respondents. This may reflect the reality that some of the most ambitious regulatory initiatives currently emerging globally, such as the European Union’s Markets in Financial Instruments Directive II (MiFID II), will have major implications for the ways institutions account for and manage risk and for pre and post-trade transparency.

One thing is clear: post-crisis prudential rules have increased the focus on the impact of short-term events on portfolio valuations. “Short-termism is largely a reflection of the way books are accounted,” says Mr Woods of Credit Suisse. “For many years it was a process of accrual and books were managed over a much longer time horizon. If you had a bond it was booked at par at the beginning and at par at the end… now there is much more focus on volatility and the P&L because of the requirement to mark-to-market.”

Rolling with regulation



A rising tide

Institutional investors in Asia have generally been seen as lagging those in other regions in terms of adopting ESG investment principles or targets. A report by the Global Sustainable Investment Alliance found sustainable and responsible investments accounted for just 0.8% of managed assets in Asia in 2016 (excluding Australia and Japan), unchanged from 2014 and compared to 52.6% in Europe and 21.6% in the United States.8

This looks set to change. The same report found sustainability-themed investments are growing across the region at 73% annually, helped by the increasing interest in green finance in its largest economy, China. Sustainable assets in China swelled from US$450m in 2014 to almost US$3bn last year as the country pursues a cleaner energy policy.

Our survey also points to ESG being a rising regional force. Almost two-thirds of Asian investors polled (62%) expect to increase exposure to ESG or principle-based investments over the next three years, and 22% expect to boost exposure in the next 12 months. Only 12% have no plans at all

to increase investments of this type. This in line with views in North America and EMEA, indicating a degree of convergence in the ESG outlook.

The region’s largest investors are also leading the sustainability charge. Japan’s GPIF has established an ESG division, and sustainability is a chief consideration for Singapore’s Temasek, according to Mr Ewing-Chow.

“Temasek considers environmental, social and governance factors when we make decisions as an investor, asset owner and shareholder,” he says. “We encourage companies, including our own portfolio companies, to adopt responsible and sustainable practices in their businesses, operations and supply chains.”

Mr Woods of Credit Suisse sees the confluence of demand for sustainable investing from multiple stakeholders having an impact. “We take social impact investing very seriously, partly because investors are demanding it and also because shareholders and activist shareholders are demanding it, whether it is embedded as a requirement or as a specific social impact fund,” he says.

Seeking a sustainable future 3

Increasing exposure to ESG or principle-based investments% respondents

Yes, increase it in the next 1 to 3 years

Yes, increase it in the next 0-12 months


No intention to increase level of ESG or principle based investments


Don’t know

41

22

17

12

9

1%



Navigating a new world of ESG investment

While overall trends are positive, there are also indications of duration-related tensions in strategies towards sustainable assets. Among Asian investors polled, 87% say changing demographics are at least to some extent causing them to shorten ESG holding/investment periods; 85% say the same of technological disruption; and 78% the same about climate change concerns.

As many sustainable assets—for example, clean energy installations, or green buildings and transportation networks—are built and designed to deliver over the longer-term, this points to a degree of concern about the ability of these assets to meet long-term goals. Investors may be rightly worried, for example, about demographic decline affecting the financial viability of an environmentally friendly, urban light rail system, while seasonal variations brought about by climate change could threaten the productivity of wind and solar farms.

A lack of consensus on what exactly constitutes sustainable investing could also be playing a part. “All asset owners I speak to say they are supportive of ESG; the only challenge is the implementation,” says Mr Wong. “There are some big funds that give specific ESG mandates, but it’s not as simple as it looks as everybody uses different measurements. For example, is it good to outsource or bad? If you are outsourcing, is it okay to outsource to Vietnam? China? Russia?

“However, in the long run, ESG investing should deliver better returns as it won’t have a negative

impact on your reputation, and if you’re following sustainability principles you won’t be fined by a government for making an environmentally damaging investment.”

With demand for sustainable assets on the rise, there has been a wellspring of innovation in sustainability-themed products that will support the sector’s further growth while simultaneously addressing various investor needs in terms of time horizons, yield and risk tolerance. Vehicles have emerged to channel funds into everything from clean water to sustainable forests. China has swiftly emerged as the world’s biggest green bond market. In Australia, social impact bonds—a relatively untested asset class in which the proceeds are used to fund social goals or projects—have met with strong appetite from institutional investors. With both regulators and investors pushing for more ESG adoption and disclosure, this field will be even more vibrant in the years ahead.

The question is to what extent the region’s institutional investors will be able to seize these opportunities while managing their other obligations, as well as the short-term risks and long-term forces likely to put even the most meticulously-planned strategies to the test.

As FWD’s Mr Carrett says, “As investors, we can generate returns by diversifying sources of alpha and making sure bets are not highly correlated.”

“It’s not easy – but you hope that some of your bets are paying off while others will pay off in the future.”



Appendix: Survey results

Percentages may not add to 100% owing to rounding or the ability of respondents to choose multiple responses.

Non-c-suite

C-suite

A. Which of the following best describes your title? Please select one.

52%

48%

$1bn-$5bn

$5bn or more

B. What are your organisation's global assets under management in US dollars? Please select one.

64%

37%



Commercial banks

Insurance companies

Pension fund

Endowment fund

Corporate treasury fund

C. Which of the following most closely describes the organisation that you currently work for? Please select one.

28%

26%

21%

15%

11%

Investment management

General management

Business development

Finance

Strategy

Other

D. What is your main functional role?Please select one.

31%

21%

21%

15%

13%

1%



Share responsibility with others

Personally responsible

Advise, but not personally responsible

E. To what extent are you responsible for making your company’s investments decisions? Please select one.

66%

32%

3%

Market volatility

Reputational risk

Short term requirements

Global economic outlook

Regulatory change

Lack of staff incentives

Governance rules

Media influence on decision makers

Silos within the organisation

35%

29%

27%

27%

23%

17%

15%

15%

14%

1. What do you consider to be the biggest impediment to lengthening the investment horizon? Please select up to two.



2. What aspects of the investment process do you believe to be most impacted by regulatory change? Please select up to two.

Provisions for post trade compliance

Provisions for investor protection covering the entire lifecycle of investment products and services

Provisions for pre and post trade transparency

Provisions for internal risk review

Provision of policies to supervise new technology/technological disruptors

Don’t know

57%

53%

50%

27%

13%

1%

3. Given the changing global regulatory environment, where do you think opportunities for alpha creation will arise over the next 3-5 years? Please select up to two.

The development of new products

The opening of new markets

Through an increased focus on factors

Differentials in regulation across jurisdictions increasing arbitrage opportunities

Through new/advanced technology solutions/tools

There will be limited opportunity for alpha creation over next 3-5 years

Don’t know

48%

38%

36%

34%

23%

10%

1%



4. What are your short-term concerns around regulatory change? Please select up to two.

66%

32%

2%

Mitigating compliance issues

Mispricing of risk

Difficulties in the re-allocation of internal resources

Competing objectives

Disjointed regulation with material impact on returns

None of the above

51%

48%

38%

33%

26%

3%

Fiduciary responsibility

Principles/social objectives

Long-term performance

Short-term performance

Reputational risk

28%

27%

21%

17%

9%

5. What drives your portfolio monitoring? Please select one.



6. To what extent have the following trends caused you to shorten your average hold/investment period for ESG investments? - Changing demographics

Moderate impact

Some impact

Significant impact

Little impact

No impact at all

Don’t know

40%

32%

15%

10%

2%

2%

7. To what extent have the following trends caused you to shorten your average hold/investment period for ESG investments? - Growing incidence of technological disruption

Moderate impact

Some impact

Little impact

Significant impact

No impact at all

39%

36%

13%

10%

3%



Some impact

Moderate impact

Little impact

Significant impact

No impact at all

Don’t know

34%

27%

19%

18%

3%

1%

8. To what extent have the following trends caused you to shorten your average hold/investment period for ESG investments? - Growing concerns around climate change

66%

32%

2%

9. Given the changing demographic profile of institutional investors and changing governance rules within institutional investor funds, do you expect to alter your exposure to ESG or principle based investments? Please select one.

66%

32%

2%


Yes, increase it in the next 0-12 months


No intention to increase level of ESG or principle based investments


Don’t know

41%

22%

17%

12%

9%

1%



10. Which information sources do you rely upon most in helping you to develop your asset allocation strategy? Please select two.

66%

32%

2%

Company reports and financial statements

Direct personal contact (e.g., Investor meetings, roadshows)

External advisory services

General information (general news media, Website based information)

Private online financial communities/groups

Colleagues

Social media (e.g., Twitter, LinkedIn, Facebook)

Other investors

57%

57%

21%

21%

19%

13%

8%

7%

11. What do you consider the biggest risk to achieve long-term targets given longer term trends like climate change and technological disruption? Please select up to two.

Correlation risk

Non-financial risks (e.g., geo-political risk)

Liquidity risk

Short-term volatility

Capital loss

50%

47%

42%

41%

21%



12. When it comes to managing risks, how do you do this? Please select up to two.

Risk budgeting

Increasing use of alternative investments (e.g., private equity, private debt, commodities, and real estate)

Currency hedging

Diversification of traditional asset classes

Hedging with options

Volatility hedging

46%

42%

40%

33%

30%

11%

13. What best describes your global equity exposure? Please select one.

66%

32%

2%

Split between active and passive

Mostly passive

Entirely passive

Mostly active

Entirely active

Does not apply

Don’t know

37%

25%

19%

11%

6%

2%

2%



14. Given the decline in global fixed income yields and changing governance rules in response to regulatory and technological changes, have you taken on a more active investment approach? Please select one.

66%

32%

2%

It is equally split between active and passive

No, it is mostly passive

Yes, it is now a mostly active approach with some passive elements

Yes, it is now an entirely active approach

No, it is entirely passive

Don’t know

Does not apply

40%

21%

16%

14%

6%

4%

1%

No, not taking any short term actions

Yes, sometimes

Yes, frequently

Don’t know

47%

28%

24%

1%

15. Is the search for yield leading you to take short-term actions such as increasing portfolio turnover despite the increased riskiness of such actions? Please select one.

66%

32%

2%



16. In light of low yields, worsening demographics in the G-7 markets (the US, Canada, France, Germany, Italy, Japan and the United Kingdom) and the need to generate alpha, have you adjusted your average holding period for your portfolio to be shorter or longer? Please select one.

No I’ve not adjusted my average holding period

Yes I’ve adjusted my average holding period to be somewhat shorter

Yes I’ve adjusted my average holding period to be much shorter

Yes I’ve adjusted my average holding period to be somewhat longer

Yes I’ve adjusted my average holding period to be much longer

Don’t know

Does not apply

42%

31%

9%

8%

7%

4%

1%

17. Have you changed the process you use to determine your return target in response to short-term pressure? Please select one.

Yes, I have become more focused on meeting my longer-term objectives

No I have not changed the process to determine my return targets

Yes, I have become more short-termist

Don’t know

Doesn’t apply

39%

29%

26%

5%

1%



18. What do you believe to be the main concerns of institutional investors in your region? Please select two.

Financial stability risks

The economic cycle

Mispricing of risk

Market volatility

Portfolio diversification

Geopolitical uncertainty (e.g. North Korea, China/US relations)

Corporate governance

Inflation

43%

40%

30%

27%

21%

17%

15%

8%

No, a change in financial regulations has not led me to reallocate away from or towards a particular asset class

Yes, away from a particular asset class

Yes, toward a particular asset class

Don’t know

Doesn’t apply

46%

23%

22%

9%

1%

19. Has a change in financial regulations led you to actively reallocate your portfolio away from or towards a particular asset class?

66%

32%

2%



More likely

Less likely because of the need to manage risk and therefore diversify my portfolio outside the Asia-Pacific region

Don’t know

56%

32%

13%

20. Given that the Asia-Pacific region is forecasted to continue to have higher growth rates than EMEA or North America, are you more or less likely to increase your portfolio allocations to the high growth rate countries in your region (e.g., the Philippines, Cambodia, China, India)?

66%

32%

2%

21. Which asset types will you look to move into?

Equities

Bonds and other fixed income

Commodities

Alternatives (e.g., Private Equity, private debt, real estate)

Funds

Cash

50%

41%

39%

34%

19%

9%



22. Given longer-term demographic trends reflected by an aging population in some countries and a growing Islamic population in other countries in the Asia-Pacific region, have you implemented or are you planning to implement principle based investment (e.g., ESG, Sharia compliant investing) into your investment process?

Yes, I plan to implement this in the longer-term but do not see it as a strategic issue right now

Yes, I already have this as part of my portfolio allocation strategy

No, I do not plan to implement this into my portfolio allocation strategy

Don’t Know

Doesn’t apply

39%

36%

15%

10%

1%


Whilst every effort has been taken to verify the accuracy of this information, neither The Economist Intelligence Unit Ltd. nor the sponsor of this report can accept any responsibility or liability for reliance by any person on this report or any of the information, opinions or conclusions set out in the report.

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Asia-pacific Investors Seek Balance Between Risk and Responsibility

Economy & Finance