Diversified Pension Investment

China begins to put its pension fund into the capital market By Lan Xinzhen

Diversified Pension Investment

China begins to put its pension fund into the capital market By Lan Xinzhen

China has taken the first step of diversifying investment tools for its pension funds. On March 20, the National Council for the Social Security Fund (NCSSF) said on its official website that it has been entrusted by south China’s Guangdong Province to manage investment of its 100 billion yuan ($15.9 billion) pension fund for two years. This is the country’s first attempt at investing pension funds in the capital market.

Liu Jingde, Deputy General Manager of the Research and Development Center of Cinda Securities Co. Ltd., said this is a good start for China to invest pension funds in the capital market. Other cities are expected to follow soon.

Yang Yansui, Director of the Research Center of Employment and Social Security at Tsinghua University, said one of the reasons for China to diversify pension fund investment is the current situation. By the end of 2010, the balance of pension funds in the world had totaled $31.1 trillion and that in the United States had hit $18.89 trillion yuan, accounting for 60 percent of the global total. The aging process in the United States started in 1960 and the peak will come in 2055. In comparison, China began the aging process in 2001 and the peak will come in 2037. The speed of China’s aging process is much faster than that in the United States, forcing the country to maintain and increase the value of pension funds.

Returns expected

Ding Sanbao, chief accountant of the Social Security Fund Management Bureau of Guangdong Province, said they expect the returns of pension fund investment, after entrusting it to the NCSSF, will double the average in the past five years, or more than 4 percent.

In an announcement on March 21 the NCSSF also said Guangdong will get returns not lower than the interest of time deposits in the same time with the pension fund it entrusts to the NCSSF. At present, the interest rate for a two-year time deposit is 4.4 percent.

Guangdong has the biggest pension fund balance in China. In the first 11 months of 2011 alone, the province had an increased balance of 110 billion yuan ($17.49 billion) and the total balance reached 441.3 billion yuan ($70.16 billion). According to state laws, local pension funds can only be invested in time deposits or treasury bonds. Restricted by the investment channels, among the pension funds managed in Guangdong in 2010, 91.25 percent were invested in time deposits and 1.63 percent in bonds, with total returns of only 3.5 percent. In April of the same year the consumer price index (CPI) of the province rose by 5 percent. The investment returns rate of the social security fund is lower than the inflation rate, leading to actual depreciation of the pension fund. What is worse is that in the previous five years, the investment returns rate had been even lower—only 2 percent—far lower than the interest rate of one-year time deposits.

Hence, a 4-percent returns rate will be a big improvement for the pension fund of Guangdong Province.

In fact, low returns and depreciation of the yuan due to higher inflation rate are common in China. Pension funds in the country are managed by local governments. Zheng Bingwen, Director of the World Social Security Research Center at the Chinese Academy of Social Sciences, once estimated that the balance of pension funds in various localities of China totaled 1.9 trillion yuan ($302.07 billion), but the investment returns rate during the past decade was less than 2 percent, lower than the CPI growth during the same time and almost the lowest in the world.

Compared with the low returns of pension funds managed by local governments, the high investment returns of pension funds managed by the NCSSF is quite attractive. Beginning December 2006, the NCSSF was entrusted to manage 54.36 billion yuan ($8.64 billion) in individual accounts subsidized by the Central Government. Individual accounts are one of the components of China’s pension fund system, which consists of social collected funds and individual accounts. The former, paid by employers, is equivalent to 20 percent of the employees’ average monthly wage in the previous year, and the latter, paid in monthly installments by employees, equals 8 percent of their average monthly wage from the previous year.

By 2011 the investment returns rate of the NCSSF-managed fund reached 10.27 percent, nearly 8 percentage points higher than the inflation rate during the same period.

Given the present investment returns for the funds managed by the NCSSF, it will be easy to reach the goal of investment returns set by Guangdong Province.

Market response

The entrance of pension funds should have been good news for the capital market, but China’s stock indices still continued to drop after this news.

This news has dampened the enthusiasm of stock investors who were hoping the entrance of pension funds would inject new life into the stock market.

In fact some securities companies have been unenthusiastic about the entrance of pension funds because, according to Chinese laws, no more than 40 percent of pension funds are allowed to enter the stock market. That is to say, of the 100 billion yuan entrusted by Guangdong Province, a maximum of 40 billion yuan ($6.36 billion) can enter the stock market, which will produce a tiny effect of boosting the stock market compared with the 20-trillion-yuan-plus ($3.18 trillion) value of the A-share market.

FULL COVERAGE: Local residents receive their pensions at a Social Security Center in Nanning, capital of Guangxi Zhuang Autonomous Region, on February 27. Since January 1, Guangxi’s old-age social security system has realized full coverage

Liu said there was no reason to expect a bull market just with the entrance of pension funds. “Only when it is combined with a wellperforming real economy, favorable policies and operational cycles of the stock market, can it help boost a bull market,” he said.

Fan Wei, chief analyst of the Department of Fixed Returns Securities at Hongyuan Securities Co. Ltd., said the securities regulatory commission and investors had high expectations of the entrance of pension funds, which could boost the A-share market, but the coming of a bull market will be quite slow, because pension funds are the lifeline for people and no mistake is allowed. “I think the entrance of pension funds is unlikely to be positive news in the short term,” said Fan.

However, some other researchers disagree. They are optimistic about the opportunities brought out by the pension funds in the long term. Li Daxiao, Director of Yingda Securities Research Institute, is among them. According to him, this means the government has opened the floodgates for more local pensions to enter the stock market, which will enhance the power of buyers. The country has a pension fund balance of 1.9 trillion yuan ($302.07 billion). If all pension funds are entrusted for investment, 760 billion yuan ($120.83 billion) will enter the stock market.“If they don’t enter the capital market, it will be hard for the growing pension funds in China to find a better way to maintain or increase their value. The successful operation of pension funds managed by the NCSSF is a good reference, which can both enhance the management of local pension funds out of low returns and bring more hopes to the stock market,” Li said.

More importantly, said Li, the entrance of pension funds, as a powerful buyer, can change the long-existing favoritism of capital raisers in the stock market, better balance the power of capital raisers and investors, increase the demand for blue-chip stocks, improve corporate governance, increase shareholders’ returns, form an investment atmosphere and orientation of long-term value investment and promote sound operation of the capital market.

Still controversial

The entrance of pension fund of Guangdong Province did not stop the argument of whether pension funds should be invested in the capital market. Instead, the argument has intensified.

Supporters think entrance of pension funds can both make up for fund shortages and input more cash into the stock market, being a good idea which kills two birds with one stone. Others are concerned about unaffordable risks if pension funds, also called people’s lifeline, are put into the unpredictable stock market.

According to Zheng, some people don’t want pension funds to enter the capital market for fear of possible losses. However, losses in the stock market are only worries, while losses without entering the stock market are concrete fact. In 2011 the CPI rose by 5.6 percent, but the investment returns rate of pension fund was less than 2 percent, leading to 100 billion yuan ($16 billion) of losses in the pension fund. In 2010 the CPI rose by 3.3 percent, and the investment return rate of pension funds was still less than 2 percent, with 30 billion yuan ($4.77 billion) lost. In the last two years, a total of 130 billion yuan ($20.67 billion) of pension funds was eaten by inflation.

Zheng said pension funds should make long-term investments in the stock market. In Europe and the United States 20-30 years after pension fund is invested in the stock market, the average returns rate surpassed 7 percent.

However, this has not persuaded everyone to believe the “legend” that once invested in the stock market, pension funds will make money. People in the capital market and local management authorities of pension funds are supporting the entrance of pension funds. Most of the worrying and opposing voices come from scholars who are without administrative power. A commentary inChina Youth Dailyonce said that the real owners of pension funds are completely silent during this argument.

China’s pension funds consist of money paid by both employees and employers, and the government adopts uniform management and distribution of the fund. The real owners of pension funds are employees instead of the management authorities of pension funds or the administration authorities of the capital market.