NEW YORK - Global capital markets are set to receive a massive boost from pension funds looking to invest an additional $2.1 trillion in net new investments over the next five years, according to a report published by Goldman Sachs Global Research in New York.
At least half of the new money will flow into cross-border equities and a further third will go into domestic stocks, according to the report, "The Global Pension Time Bomb And Its Capital Market Impact." However, relatively little will be invested in bonds, real estate, cash and other asset classes.
Industry experts believe this wave of new money will have a major impact on world equity markets, soaking up new and existing issues, driving up current stock valuations and forcing the introduction of new valuation techniques such as economic value added.
"If you believe the switch into long-duration investing is here to stay and there's a shift into equities because of higher returns, then equity markets will remain stubbornly high," predicted Said H. DeSaque, an economist and senior vice president with PaineWebber International (U.K.) Ltd in London.
Not all observers, however, are convinced capital markets will necessarily receive such a huge fillip. One consultant dismissed the report as no more than a broker talking up its own book. "Net flows are zero. But if you say that, people get upset," said Andrew Smithers, who heads his own consulting firm, Smithers & Co., London.
"I spend most of time taking sweets away from children," he said.
The Goldman report estimated future net new investment by subtracting current pension growth rates of 6% annually from year 2000 projections. It did not, however, speculate whether there would be enough equity issuance to satisfy this increased demand.
But industry experts think there's unlikely to be any shortage of suitable investments. According to Privatisation International, a London-based specialist business publication, $87.4 billion in companies were privatized in 1996 and a similar, if not greater, amount will be privatized over the coming year, and this figure will grow exponentially over the next five years.
This potential buying bonanza is the result of changing demographics in the ratio between retirees and workers that are likely to swell global pension assets to $12 trillion by year-end 2000 from $7.3 trillion at the end of 1995
Japan is likely to be the largest beneficiary of the new money with non-domestic pension funds pouring some $300 billion into equities. However, the report's author, Executive Director Mark Griffin, noted the large figure for Japan reflected the size of its market capitalization rather than any unique investment attractions.
U.S. and U.K. stocks, meanwhile, will receive an additional $250 billion and $150 billion, respectively, from overseas pension funds. And the U.S. equity market can expect a further net inflow of $500 billion from domestic pension funds over the same period. Combined, that represents 7.5% of U.S. stock-market capitalization.
But, with the exception of the United States and Canada, the majority of incremental pension fund demand for equities will come from non-domestic pension funds.
However, major developed countries won't be the sole beneficiaries of this burgeoning demand from pension fund investors. "It also has a positive impact for emerging markets because Western nations need to diversify their investments," observed Sarah Hewin, a senior economist at American Express Bank in London.
Indeed, according to the Goldman report, emerging markets such as South Africa, Brazil, Mexico, Malaysia, Singapore and Thailand will receive more than $60 billion in new investments during the next five years.
Aside from changing demographics, other factors influencing the dramatic growth in equity investment include the removal of trade barriers, the gradual relaxation of existing investment restrictions, more sophisticated asset allocation and an increased awareness and use of currency hedging.
Japan, in particular, has indicated its willingness to dismantle trade barriers and is currently relaxing its 5-3-3-2 investment rule, which stipulates at least 50% of a fund's assets remain in principal guaranteed investments and no more than 30% be invested in Japanese equities and 30% in foreign equities.
Goldman's Mr. Griffin argues the increase in cross-border flows has been evident for some time. The international element of world pension fund equity portfolios grew to 21.1% from 12.1% between 1991 and 1995, he said. A projected increase to 31.9% of equity portfolios by 2000 represents a similar rate of growth.
Similarly, the allocation to domestic equities also represents a continuation of current asset allocation trends and demographic developments. Overall, total equity asset allocation rose to 49.2% between 1991 and 1995 and the projected overall increase to 55.5% by 2000 represents an almost identical rate of change.
Allocations to fixed-income securities, however, are likely to remain relatively static.
Between 1991 and 1995, for example, the overall allocation to international bonds as a percentage of total bonds increased only marginally to 7.3% from 6.4% and domestic fixed income fared little better.
Furthermore, lack of appetite for fixed income raises the intriguing possibility of many governments failing to raise enough cash to finance their pay-as-you-go pension systems.
Indeed, the possibility of this happening is already forcing many countries to follow the example set by the governments of Chile and Singapore and privatize their social security systems, observed PaineWebber's Mr. DeSaque.
However, many of the arguments in favor of greater equity investing presuppose that inflation will remain low and demand from pension investors will remain high.
But if inflation returns and baby boomers retire early, the outlook for equities might not be so rosy.
"Presumably they'll cash in their investments and buy an annuity, which implies fixed interest and a shift back into bonds," said Stephen Oxley, vice president at InterSec Research Corp. in London.