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  2. DEFINED CONTRIBUTION
January 21, 2019 12:00 AM

Optimism abounds on China's new savings pillar

Despite slow start, third vehicle for retirement savings has its fans

Douglas Appell
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    Qilai Shen/Bloomberg
    China is using the new third pillar to help its population shoulder more of the retirement burden.

    China's push to get its citizens to shoulder a greater share of their retirement savings burden got off to a slow start last year, with a vicious bear market dogging the debut of the "pension target" fund-of-funds offerings sanctioned by regulators as a new third pillar of the country's retirement safety net.

    But few market participants appear eager to bet against the house.

    Amid signs policymakers are committed to making the fully funded savings scheme an important piece of China's retirement puzzle, market participants predict near-term obstacles will be overcome, positioning the target-date funds — a mutual fund-based fund-of-funds vehicle with fees of between 50 basis points and 100 basis points — as a compelling business opportunity for money managers.

    The past year — which saw China's Shanghai and Shenzhen stock markets both dropping more than 20% — resulted in an "asset gathering hiccup," said Nixon Mak, Hong Kong-based pensions and solutions strategist, Asia-Pacific, with Invesco Ltd. Only a fraction of the 44 pension-target funds approved since August have come to market, he said.

    Over the medium to long term, however, those funds — positioned by regulators as a third-pillar complement to the government's pay-as-you-go first pillar and its corporate enterprise annuities second pillar — are set to be "one of the growth engines" for raising assets in China, he said.

    China is actively promoting the policy framework for that third pillar, a retirement savings initiative China Southern Asset Management Co. Ltd. believes is both "imperative and bound to succeed," said Yu Jin Hua, head of macro research and asset allocation with the Shenzhen-based manager of roughly 1 trillion yuan ($148 billion) in assets under management.

    Even so, there are likely to be bumps along the way.

    Getting it right

    While the third pillar has the potential to attract a huge amount of assets over time, getting the fundamental building blocks right, including tax incentives and investor education, will pose big challenges, said Miao Hui, Shanghai-based senior analyst with Cerulli Associates Asia Pte. Ltd.

    As of early January, the first 12 pension-target strategies to come to market had raised 3.9 billion yuan from 700,000 individual investors through a combination of bank distribution, direct sales and e-commerce platforms, said Claire Liang, a Shenzhen-based managing research analyst with Morningstar Inc.

    Manulife TEDA Fund Management Co., a 49%-51% Shanghai-based joint venture between Manulife Asset Management and Tianjin TEDA Investment Holding Co., raised 231 million yuan from 40,703 subscribers in its fund's initial public offering period ended Oct. 22, through bank distribution and e-commerce platforms, said Calvin Chiu, Hong Kong-based senior managing director and head of Asia retirement with Manulife Asset Management.

    China's pension industry

    Pillar 1Pillar 2Pillar 3
    Compulsory

    basic pension

    Enterprise

    annuities

    Occupational annuitiesIndividual pension product
    Compulsory/

    voluntary

    CompulsoryVoluntary CompulsoryVoluntary
    Applicable toChinese citizensCorporate staff Civil servantsIndividuals
    Responsible entityGovernmentCorporates and individualsCorporates and individualsIndividuals
    Established1997200420162018
    Source of contributionsDB, pay-as-you-go segment funded by mandatory employer contributions of 20% of employee salaries, and a DC (notional) segment, funded by mandatory contributions of 8% of employee salariesEmployers: max 8% salary; individuals: max 4% salaryEmployers: max 8% salary; individuals: max 4% salaryIndividuals
    AUM4.4 trillion yuan1.4 trillion yuanEstimated to be in excess of 200 billion yuan once fully implemented
    Coverage858 million people as of the end of 201523.5 million people as of September 2018 Estimated to be 37 million employees Part of broader wealth management market
    Sources: AMP Capital, ZiAsset Consulting and China's Ministry of Human Resources and Social Security

    Subscribers are able to make regular monthly follow-on investments, although only a small portion are doing so at present — "highlighting the need for investor education and engagement," Mr. Chiu wrote in an email.

    Lock-in periods of one, three or five years for pension target funds ensure investors, who came in during the final quarter of 2018, won't make the mistake of selling hastily when volatility spikes. At the same time, the uncertain market backdrop is forcing managers to raise their game when it comes to communicating with clients, Mr. Chiu said.

    The government, meanwhile, is expected to extend tax incentives — allowing deductions of up to 1,000 yuan a month — to pension target funds as early as May.

    Some analysts expect the move to help the fledgling sector to gain traction. The official implementation of tax deferrals could prove "pivotal" for the third pillar, said China Southern's Mr. Yu.

    Others, however, note that the number of taxpayers in China, at less than 10% of the population, is small and — as of late 2018 — potentially getting smaller.

    At the end of 2018, China raised the trigger point for paying personal income tax to 5,000 yuan from 3,500 yuan, while adding deductions for housing loans, rent, education, medical expenses and support for the elderly — significantly reducing the scope for using tax deductions to boost pillar three, said Keyong Dong, a professor at Beijing-based Renmin University of China's School of Public Administration & Policy.

    Against that backdrop, Mr. Dong said financial subsidies might need to be considered to get low-income groups to participate.

    Clearing roadblocks

    If there are hurdles to pillar three becoming an engine of China's retirement savings growth, analysts predict policymakers will find a way to clear them.

    Pillar three "is a pilot program (with) issues that need to be ironed out, but they will be ironed out, I'm absolutely certain" — even if the timing, whether it be 12 months or three years or five years, is uncertain, said Josef Pilger, Sydney-based partner and global pension and retirement leader with Ernst & Young.

    At just more than $500 million, the amount of money pension target-date funds have attracted so far is hardly material for a country facing a retirement savings gap that the World Economic Council, in a May 2017 report, predicted would surge to $119 trillion by 2050 from $11 trillion at the end of 2015 if no further steps are taken to strengthen China's safety net.

    Still, it's "really, really early days," and the initial results for pension target funds of funds in a very weak market environment can be seen as reasonable, said Jackson Lee, Shanghai-based country head, China, with Fidelity International.

    For Chinese policymakers, meanwhile, the figure showing 700,000 investors subscribing to third-pillar funds is probably more significant than the initial amount of assets taken in, and a reason to be hopeful, he said.

    Fidelity — which avoided accepting the minority joint venture partner status that, until recently, was the only means for global managers to access retail investors on the mainland — forged a strategic partnership in August with domestic heavyweight China Asset Management Co., Beijing, to develop pension-target products for the local market.

    The government's interest in promoting a fully funded voluntary pension savings scheme reflects the growing squeeze China's looming demographic time bomb is poised to visit on the country's mostly pay-as-you-go 4.3 trillion yuan basic pension, which garners mandatory inflows from employers of 20% of employee wages.

    With the number of Chinese employees supporting each retiree set to plunge to two from seven over the coming decade, dependence on that pillar one pension can only be "very worrying," noted Wina Appleton, J.P. Morgan Asset Management's Hong Kong-based retirement strategist for the Asia-Pacific region.

    Pillar one also has a defined contribution segment, with employees making mandatory contributions of 8% of their salaries to notional individual accounts. Details are few but there's reason to believe that a portion — perhaps a quarter — of that defined contribution money has been diverted to cover other social security-related expenditures, said Stuart Leckie, chairman of Hong Kong-based China pension consulting firm Stirling Finance Ltd.

    Receiving more attention

    Meanwhile, China's enterprise annuities program — launched almost 15 years ago as a supplementary corporate retirement scheme — has seen combined assets under management edge up to 1.4 trillion yuan on the participation of roughly 23 million employees, mostly with big state-owned companies. Growth stalled in recent years as private-sector firms have declined to add to the retirement outlay burden they face under the first pillar.

    But an earlier decision, just being implemented now, to add a mandatory occupational annuity plan, covering 37 million government and public institution employees, is slated to reignite second-pillar growth, analysts said.

    Currently, "over 80% of China's retirement assets are in pillar one," but growth of the other pillars increasingly will outpace pillar one, with pillar two leading in the near term and pillar three picking up the slack further down the road, said Ben Ma, a Shanghai-based associate principal with McKinsey & Co.

    Dong Mei, a Beijing-based director with KPMG, said the combined assets of pillars two and three could surpass pillar one's size by 2025.

    Some analysts, while contending it could take more time for pillar one's share of China's retirement assets to drop below 50%, still advise money managers looking to pursue opportunities in those fully funded pillars to get off the sidelines sooner rather than later.

    The right time to be bullish about those fast-growing retirement segments could be within three to five years, but managers would be well advised to be investing in the interim to build their market presence, said Anu Sahai, a Singapore-based senior adviser with management consultant McKinsey & Co.

    It won't be easy, some warn.

    Ernst & Young's Mr. Pilger said he's optimistic about the "tremendously attractive opportunities" in China's asset management market but less confident foreign managers will be able to take advantage of them in the face of increasing competition from domestic managers.

    "Who's actually going to win?" Mr. Pilger asked. The best advice for foreign money managers blinded by China's growth prospects now would be to "mind your step," as opposed to jumping into the market and wasting a lot of money and energy.

    On that score, foreign managers' competitive edge, in areas such as global asset allocation for pension target portfolios could provide an opening, noted Ivan Shi, research director with Z-Ben Advisors, a Shanghai-based consultancy on financial industry opportunities in China.

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