Cover Story: What population ageing means for your investments

This article first appeared in Personal Wealth, The Edge Malaysia Weekly, on March 23, 2020 - March 29, 2020.
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The rapidly ageing global population will have profound implications on not only global growth and savings rates but also interest rates and investment returns in the coming decades. That means current and future investors will need to assess the way they manage their finances and how to position their portfolios to take advantage of the emerging opportunities.

In three decades, the world will be on the cusp of an unprecedented era. For the first time in history, there will be a substantial increase in people 65 years and older and a shrinking number of children aged 15 and below.

According to the United Nations’ population data, it is estimated that by 2050, one in six people will be over the age of 65 (16%) ­— up from one in 11 (9%) last year. The number of people aged 80 years or above is projected to triple from 143 million in 2019 to 426 million in 2050.

Ageing populations and falling fertility rates impact nearly all segments of society, including financial markets and investments. Fewer workers result in slower economic growth, which translates into shifts in housing and consumption patterns. Experts point out that this corresponds with the decades of falling interest rates, for which demographics are a major factor.

“Profound demographic changes are transforming the societies in which we live and work globally. We view population ageing — the increasing share of older individuals in the population — as one of the most significant social transformations of the 21st century, with tremendous implications for the global economy,” says Paula Campbell Roberts, head of alternative data and analytics at US-based global investment firm KKR & Co Inc.

Ageing besets financial markets in several ways. It has the potential of impacting growth, interest rates, worker supply and productivity, and consumption trends as well as the growth or decline of various sectors.

“In general, slowing working-age population growth and lower interest rates have the potential to drive down financial returns. At the same time, there will be a greater need for yield to support the older segment of the population,” says Roberts.

Dr Yeah Kim Leng, professor of economics at Sunway University Business School, agrees. Population ageing, which is accompanied by an increase in savings, has been identified as one of the factors of the decline in the natural rate of interest, he says. The other factors are productivity growth slowdown and an increase in the global demand for safe assets. 

“A key consequence is that risk-adjusted returns on financial assets will be lower as the nominal interest rate tends to move in tandem with the natural rate of interest. The lower returns will affect the portfolio income of pension and other retirement savings funds. Risk behaviour may also change as fund managers will be forced to invest in riskier assets in search of higher returns,” says Yeah. 

While the issues surrounding rising median ages are not new, they had not received the attention they should have — especially on the local front — until recently. In his keynote address at The Third Age Economy Symposium last year, Nurhisham Hussein, head of the economics and capital market department at the Employees Provident Fund (EPF), said Malaysia was expected to become an aged nation in about 25 years. It is currently the second fastest ageing country in the world. 

When this happens, he added, there will be negative implications for both economic growth and investment returns in the next few decades. “What happens when the workforce-to-population ratio falls is that economic growth will slow. By 2040 or so, we expect Malaysia’s economic growth to slow to about 3% from roughly 4% to 5% [today]. This has a lot of implications for interest rates and the [rate of] returns from investments,” he was quoted as saying.

“If you look at what actually affects the fixed-income market, one of the best models for forecasting is via demographics. And we can strongly see that when the population ages, the interest rate drops.”

While populations in some regions are still growing rapidly — namely, most of sub-Saharan Africa and parts of Asia, Latin America and the Caribbean — and creating an opportunity for accelerated economic growth, in others, there has been a rapid expansion of the elderly population, according to the UN. 

It is projected that in a little more than a decade, there will likely be about 8.5 billion people on earth — and almost 10 billion by 2050, compared with the 7.7 billion today — but only a small number of countries will account for most of the increase. These countries are India, Nigeria, Pakistan, the Democratic Republic of the Congo, Ethiopia, the United Republic of Tanzania, Indonesia, Egypt and the US (in descending order of growth rate).

“A baby born today can live up to 14 years longer than a baby born 50 years ago, which indicates that people will live longer. In China, a baby born today can live up to 33 years longer than those born in the 1960s,” says Francis Tan, an investment strategist at UOB Private Banking in Singapore.

“In China, there are already 131 million people aged 65 and above, which is more than in the US, Japan, Germany, Italy and France combined. Although India is younger, it has 74 million people aged 65 and above, making the country only second to China. By 2045, China will have 355 million more 65-year-olds, which is more than the population of the US.”

The speed of ageing is especially remarkable compared with the historical experience in Europe and the US. Per capita income in Asia remains at much lower levels than those achieved by mature advanced economies in the past.

“Countries in Asia will have less time to adapt policies to a more aged society than many of the  advanced economies,” says Tan, pointing out that parts of Asia risk becoming old before becoming rich. 

He adds that as the population gets older, productivity growth slows and may be negative. “Companies will more urgently need to go overseas. Domestic wage growth will slow and contract. The currency will depreciate and domestic purchasing power will be reduced.

“Due to budget constraints, the working population will need to spend more money on consumption, draw down more on savings and have less left over for investments. Empirically, as income rises initially, the savings rate increases. Then, after a certain point, the savings rate declines.”

A declining savings rate does not mean that people will be saving less compared with the past, says Tan. On the contrary, longevity and slower population growth incentivises people to save more to fund a longer retirement. But this means there will be less spending.

“Thus, consumption growth will be slower than in the past. This oversaving and under-consuming [culture] will create downward pressure on natural interest rates, which are already seen in developed economies [that already have ageing populations],” he says.

“Lower natural interest rates mean that central banks will not have room to hike interest rates like before. Investment returns will be benchmarked by risk-free interest rates. This means investors are expected to make lower returns.”

The inevitable megatrend

Recognising that there is no way to circumvent this inevitable megatrend, leaders at the G20 Summit in Osaka last June were cautioned to act fast before population ageing catches up with the governments in earnest and piles pressure on their economies.

“Population ageing is perhaps best described as an issue similar to wealth inequality — it is an integral issue that has been prevalent over the decades, but remains one that is challenging to address without trade-offs,” says Kristina Fong, head of research at RAM Rating Services Bhd.

Malaysia, along with its neighbour Singapore, is among the few countries in Southeast Asia experiencing a fundamental change in age structure, with many having fewer children and living longer lives. According to the Department of Statistics, an estimated 7.2% of Malaysia’s 31 million population will be 65 and older this year. In a mere decade, the number of people living past the age of 60 is anticipated to be 15% of the population.

“For Malaysia, the characteristics inherent to an ageing population are becoming more obvious. Fertility rates have fallen below replacement rates since 2015, resulting in lower birth rates. Moreover, the dependency ratio of the retirement age demographic to the working age population has been creeping up,” says Fong.

“Using the Department of Statistics’ projections as a yardstick, the share of retirement age individuals to total population is expected to grow from 10% in 2019 to 15% in 2030, and 20% by 2040. Japan’s demographic already bears these characteristics.”

For obvious reasons, an ageing demographic could be viewed as an economic risk following the potential strain on consumption that this demographic brings, she says. “Private consumption growth could waver. Private consumption accounts for more than 50% of [the country’s] GDP and thus, remains an important driver of the economy.” 

Japan, the third largest economy in the world, is a prime example of a country mired by a growing ageing community. As it stands, more than 20% of its population is over the age of 65 — the highest proportion in the world. By 2030, one in three will be 65 and older.

“[Japan’s] current demographics are assumed to have a direct effect on its declining economic growth,” says Ling Kay Yeow, partner at Ernst & Young (EY) Advisory Services Sdn Bhd.

Japan has recorded a steady decline in real GDP growth from a five-year average peak of 5.2% in 1989 to the current average of 1.2%.

For many developed countries, the “demographic dividend” — the substantial increase in working age population — boosted economic growth and productivity in the early years, says Yeah. Clearly, as this cohort ages, the lack of productivity is a drag on economic growth, he adds. “The drag is turning into a full-blown headwind with rapid ageing in Japan, Italy and many European countries. 

“The fast-growing Asian economies such as South Korea, Taiwan and Singapore have leveraged the demographic dividend to sustain long periods of high economic growth and progressed quickly from low to middle-income, and eventually to high-income, nations. China and India as well as Malaysia and other Asean countries are also harnessing the growing working age population to sustain growth through policies that promote economic development.”

These policies are directed at increasing human capital accumulation, technological advancements, openness to trade, labour market flexibility, savings, investments, financial deepening, institutional quality and political stability, says Yeah.

As the International Monetary Fund stated in 2017, the region was shifting from being the biggest contributor to the global workforce to subtracting hundreds of millions of people from it. “Accompanying this shift are the changing dynamics of global production, trade and investment patterns, in addition to the changes in consumption patterns. There is also an impact on global immigration and labour mobility. Many developed countries facing demographic transition and ageing populations have targeted skilled immigration, which exacerbates the brain drain from poorer nations,” says Yeah.

Simultaneously, retiring baby boomers, who wield enormous economic clout, are driving increased spending on healthcare services, senior living facilities and food at home, says Roberts. “The over 60 population globally spends roughly US$4 trillion, and that number will only grow. However, we anticipate some diminished consumption in areas such as automotive and hotels, as well as weakness in traditional single-family housing, given the rapid urbanisation of older populations around the world.”

Fong says the economic risk in an ageing world presents itself through a lack of savings. In Malaysia, most of the private sector savings are accumulated in the Employees Provident Fund (EPF) through a defined contribution plan.

At the current minimum retirement age of 60 and life expectancy of 72.7 years and 77.6 years for males and females respectively, “there lies the first challenge in this age of ageing — will your savings be sufficient for the rest of your life?” says Fong. “For those with good earning power and are financially savvy, this may not be a problem keeping them awake at night.” 

But for a large proportion of the population, this is not the case. Last year, EPF stated that less than 25% of its members reach the minimum basic savings requirement by the time they reach 55 years old. 

“Although it is an alarming statistic, it needs to be viewed within a context. For one, not everyone opts to contribute to EPF. For example, those who are self-employed or those who choose to invest in other vehicles, be it a private pension scheme or even property,” says Fong.

“Moreover, some workers may leave the workforce before retirement, choosing to be homemakers and hence, stopping contributions at a certain point in time. Having said that, 25% is still a low representation of retirement adequacy.”

EY’s Ling says that with the higher withdrawals from pension and long-term funds, and lower contributions to these funds following the decline in the working-age population, the funds would have to divest to generate cash flow for withdrawals instead of dividends. “This may impact the capital market. Investors will be more cautious about their investment strategies and may look at countries with a stable growth rate and younger population. There will also be a shift in consumption patterns and areas of growth in sectors that target aged-care products and services, including healthcare and wellness.” 

 

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