Asian equity markets, which have so far been dominated by either foreign institutions or short-term trading by local individual investors, are set to see a big increase in investments from local pension funds, which will lead to higher stock prices and lower volatility, according to a new report from HSBC Global Research.
So far, most Asian investors saving for retirement have tended to favor bank deposits and real estate. However, rising incomes and the development of financial markets is leading to a greater appetite for equities and bonds, HSBC said.
“The development of pension systems can act as a catalyst to increase Asia’s appetite for liquid financial investments, such as equities,” Herald van der Linde and Devendra Joshi said in the report titled “Asia Buys Asia.”
Asia’s aging populations aren’t adequately prepared for their retirement obligations, van der Line and Joshi said in the report, pointing out that this would lead to a big increase in the growth of assets managed by pension funds in the coming years.
“Asian pension plans differ widely from one country to another. What they all have in common is that Asian retirement income plans are ill-prepared for the rapid aging of populations across the region,” HSBC said. “In addition, while the average OECD countries show that about 70 percent of the working population is covered by a pension plan, this is much lower in Asia, only 11 percent in South Asia and 37 percent in East Asia.”
Pension funds also require a 70 percent replacement ratio in order to ensure there isn’t significant drop in living standards of individuals after retirement, HSBC said, citing OECD data. But the average replacement rates in Asia are about 40 percent, a far cry from what’s needed.
The replacement rate is the value of a pension for individuals as a percentage of their earnings when working.
This means that Asian pension funds will have to start allocating a higher proportion of the capital to equities, according to HSBC.
China, Thailand, Indonesian and India are the countries most likely to see a positive impact on share prices, HSBC said. Their equity markets have the most room to increase capitalization and assets under management based on the current level of income.
The greater participation of domestic buyers, especially long-term investors like pension funds, will also make Asian markets less dependent on bigger markets overseas and may reduce volatility.
According to HSBC, emerging Asian equity markets have had an 80 percent correlation with the S&P 500 in the last 10 years. Over the last five years, this correlation was even higher at 83 percent, likely because of the global market turmoil in 2008 and 2011.
HSBC says big increases in assets managed by domestic pension funds are already being seen in countries such as Indonesia, Malaysia and India.
—By CNBC’s Jean Chua.