Published by

MARCH 2015

Examining the evolving asset allocation strategies that Asian based institutional investment groups are adopting to navigate the market challenges they face.

INSTITUTIONAL INVESTMENT STRATEGIES, ASIA

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CONTENTS

SECTION 1ADAPTING TO PRESENT MARKET CONDITIONS

1.1 INTERVIEW 5How are Korean institutional investors adapting their investment strategies given the present market conditions and regulatory environment?

Interviewer:• Chido Tagarira, Senior Publisher, Clear Path Analysis

Interviewee:• Nayoung Kim, Former Fixed Income Senior Professional, Samsung Fire & Marine

Insurance Co.

1.2 INTERVIEW 7Considering the changes to Asian based private bankers’ approach to investing

Interviewer:• Chido Tagarira, Senior Publisher, Clear Path Analysis

Interviewee:• Eva Law, Founder, Association of Private Bankers, Greater China

1.3 INTERVIEW 10An Indian based life insurer’s perspective on the evolution of investment strategies

Interviewer:• Chido Tagarira, Senior Publisher, Clear Path Analysis

Interviewee:• Ritu Arora, Chief Investment Officer, Canara HSBC Oriental Bank of Commerce Life

Insurance

SECTION 2THE VALUE OF DIVERSIFICATION

INTERVIEW 13How can exposure to alternatives enhance investment portfolios and help to generate consistent returns?

Interviewer:• Chido Tagarira, Senior Publisher, Clear Path Analysis

Interviewee:• Siti Rakhmawati, Head of Investment Analyst, PT Telekomunikasi Indonesia

Pension Fund

SECTION 3THE ASIA REGION FUNDS PASSPORT REGIME

INTERVIEW 16Expectations for the Asia Region Funds Passport regime

Interviewer:• Chido Tagarira, Senior Publisher, Clear Path Analysis

Interviewee:• Manuel Huberto B. Gaite, Commissioner, Securities and Exchange Commission,

Philippines

Institutional Investment Strategies, Asia

Manuel Huberto B. Gaite Commissioner, Securities and Exchange Commission, Philippines

Siti Rakhmawati Head of Investment Analyst, PT Telekomunikasi Indonesia Pension Fund

Ritu Arora Chief Investment Officer, Canara HSBC Oriental Bank of Commerce Life Insurance

Eva Law Founder, Association of Private Bankers, Greater China

Nayoung Kim Former Fixed Income Senior Professional, Samsung Fire & Marine Insurance Co.

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Chido TagariraSenior Publisher

Libby BritcherMarketing & Operations Manager

Jim AllenSenior Digital Producer

Noel HillmannManaging Director & Head of Publishing

Jennifer MenoscalMarketing Assistant

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SECTION 1ADAPTING TO PRESENT MARKET CONDITIONS

How are Korean institutional investors adapting their investment strategies given the present market conditions and regulatory environment?

1.1 INTERVIEW

Considering the changes to Asian based private bankers’ approach to investing1.2 INTERVIEW

An Indian based life insurer’s perspective on the evolution of investment strategies 1.3 INTERVIEW

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Chido Tagarira: What economic factors have had an impact on Korean institutions’ investment strategies over the last 3-5 years?

Nayoung Kim: The low yield environment in Korea has definitely had an impact on investment strategies. The economy hasn’t been growing as rapidly as it had been throughout the 1980s and 1990s.

Korea has been facing its first deflationary status and although the economy has been growing, its growth has stagnated to 3% levels, hence its rates have been coming down in tandem with the slowing growth. The market isn’t used to this, and fixed income investors in particular are not used to this environment, so they are trying all means possible to pick up additional yield.

Chido: What strategies are investors looking at to try and pick up this additional yield?

Nayoung: More Korean institutional investors are looking towards foreign assets and currencies. Their strategies are largely being driven by fluctuations in the foreign exchange rates of various currencies.

For example, in 2014, Chinese offshore yuan (CNH)-denominated deposits were a big hit among Korean institutional investors because there was a slight temporary misalignment between the short-term interest rate of the Korean won (KRW) and CNH. Due to this, there was a temporary phase where investing in CNH and converting it into Korean won helped Korean investors pick up around 100-200 basis

points of additional yield in terms of foreign exchange (FX) premium alone. In addition, the rates of CNH deposits were obviously higher than KRW denominated deposits. Therefore, Korean institutional investors could enjoy both the high yield to maturity from the deposit rates, as well as the additional pick-up that comes from the divergence between the foreign exchange rates and the rate environment of the two countries.

Nowadays, you can’t really find this anymore because the rate environment has normalised. Additionally, Korean papers (KPs) denominated in USD were a very hot topic among Korean investors until 2014 as a means of picking up additional yield without layering additional credit risk. However, KP yields have tightened notoriously and FX premium arising from USD-KRW swaps are diminishing, so this is not the case anymore. As a result, Korean institutional investors are now looking at emerging market paper that is denominated in USD and other local currencies, as well as opportunities that come from other minute divergences in the foreign exchange rate environment.

Korean institutional investors have become a lot more nimble. If you go back a decade or so ago, being a fixed income investor in Korea – especially as a liability-driven investor with local currency liabilities in Korea - was relatively easier because we had higher yields than other developed countries. In today’s world, things have shifted and Korea is on the verge of becoming an emerging market or developed country, and it has relatively low yields because of its stability and the liquidity

both around its local and foreign currency denominated paper.

The institutional regulatory environment is focusing more on the risk-based capital of institutional investors themselves.

Chido: What types of investments typically make up the bulk of Korean institutions’ portfolios?

Nayoung: Given the yield perspective as well as the nature of the market, public fixed income and equity takes up the lion-share of their investment portfolios. Institutional investors are also realising that they can’t rely on public markets alone anymore, and Korean equities have relatively lower dividend yields so it is more difficult to gain a stable income from Korean equity investments.

More investors are looking at alternative investments. The National Pension System (NPS) of Korea is also looking to diversify into hedge funds. Other conservative institutional investors have been looking into the possibility of investing in private equity or hedge funds but this is still at a very nascent stage.

Chido: Do you think that hedge funds might start to come on the radar for other institutions based on what happens with the NPS?

Nayoung: If the NPS does make a move, it would be a great opportunity for hedge funds. There would be a strong marketing push from hedge funds especially from those who are operating within Asia or the bigger global names as NPS would be a

1.1 INTERVIEW

How are Korean institutional investors adapting their investment strategies given the present market conditions and regulatory environment?Interviewer Interviewee

Nayoung Kim Former Fixed Income Senior Professional, Samsung Fire & Marine Insurance Co.

Chido TagariraSenior Publisher

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How are Korean institutional investors adapting their investment strategies given the present market conditions and regulatory environment?

large chunk of money. The bigger institutional investors and those that are more government-orientated tend to be very conservative, so even though NPS is looking to include hedge funds in their asset portfolio, capital loss is seen as a big failure particularly for institutions who have a large fixed income portfolio. So it isn’t going to be that easy because the nature of hedge funds is that although you can make a lot of money, there is also a large risk attached to it.

The biggest hurdle for these institutions’ alternative investments would be whether or not these institutions would be able to reshape their risk tolerances. As with equity, or other investments in other funds which can result at least in a temporary loss, it is a question of how, and whether, they can or should make up for it.

Chido: Has the regulatory environment played an influential role in the types of investments that investors now allocate to? Are there any specific regulations for institutional investors in Korea that you are bound by?

Nayoung: Since 2008, Korea has been fairly aligned with the global regulatory environment. Similarly to most other countries, they have tightened the capital requirements for financial institutions and asset managing institutions following the crisis.

It is becoming much more difficult for institutional investors to make money in Korea because we are in a low yield environment, but our capital requirements are tighter than what they used to be in a better yield environment. This is the reason why people are looking at more niche markets and alternative assets. This trend will continue but might take more time to see whether or not Korean institutional investors would actively invest in such products because most institutions have had to deal with losses – big or small - post 2008. Korean institutions have had

some exposure to derivatives and structured products, some of which culminated in a loss during the 2008 crisis. As a result, Korean institutional investors are more sensitive to the global environment, even though there is a growing consensus that they have no choice but to take more risk in the current investment environment.

Chido: What strategies do Korean investors consider when putting together their de-risking plans?

Nayoung: It depends largely on the investment mandate of the investor. For the conservative, liability-driven investor, there is little room to further de-risk because the bulk of their assets are already in relatively safe Korean won-denominated local bonds issued by state-owned agencies or the Korean government. Therefore, ironically, these investors will be pressured to take more risk in a tighter regulatory environment.

As for the alpha chasers, managing currency risk has always been important, especially if you’re managing a KRW-denominated book and are actively searching for yields in emerging market paper. I also see concerns surrounding the whereabouts of the Bank of Korea rates in light of a potential U.S. fed rate increase, since it’s likely to impact both the net asset value of local bond portfolios and the FX premium of overseas investments portfolios.

Chido: Thank you for taking the time to share your thoughts on this.

“they have no choice but to take more risk in the current investment environment. ”

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Chido Tagarira: What does the Association of Private Bankers and the Association of Family Offices do?

Eva Law: The Association of Private Bankers (APB) is a professional body which was set up 5 years ago to gather private bankers in our region. We later ventured into China. The people there have mixed experience and are relatively more aggressive than those in other markets.

We have been approached by many professionals and intermediaries serving the ultra-affluent to join the association. We even receive requests to join from asset owners, and have gained fast-paced growth with wide reaching capabilities due to the ambassadors’ efforts. As a result, we have been under pressure to create additional memberships for those who are not private bankers but are servicing very wealthy customers such as those from auction houses, real estate, investment banks, commercial banks or private equity funds.

Presently, the APB is made up of around 60-70% private bankers, and the rest come from other sub sections that fall within the financial industry and real asset related industries.

The Association of Family Offices (AFO) was founded 2 years ago. The membership here is different to the APB because all of the members are family offices covering single family offices (SFOs), multi-family offices (MFOs), virtual family offices (VFOs) and boutiques in Asia. They are all institutional investors and many have been established for a few decades.

Some members are newly advanced to the emerging ultra-wealthy class.

The APB offers professional training and organises activities to foster knowledge exchange. It also promotes long-term industry development, supports collaboration among practitioners, and delivers a range of professional services to wealth owners. The AFO offers a range of consultancy services, sources investment projects and organises activities to facilitate collaboration and co-investment among the prestige circle.

Therefore, I will be speaking mostly from the private bankers and family offices’ perspective.

Chido: What economic factors have had an impact on these institutions over the last 3 years?

Eva: The important factor is the extremely loose monetary policy of the major governments with which they were injecting ample liquidity into the market, as well as the recent turn towards the path of re-domiciliation. There has been unprecedented intervention by central banks to keep the interest rate near zero in major economies like Europe, Japan, UK, U.S. and China, even though the rate has been coming down over the past few years. As asian wealth owners allocate more into the traditional fixed income and bond vehicles, this has posed many challenges.

Many private bankers are receiving a lot of of feedback as they structure solutions. When the rates come down, it is not easy to find real returns, so they try to use structured solutions. They

use zero-coupon bonds and bundle it with options for making capital or return guaranteed, and of course this is not easy as these vehicles are also sensitive to the interest rate. This will continue to have an impact on overall investment in the banking space in the coming years. The rates will start to climb but the rise will increase on a very gradual basis. Japan and Europe will still be facing their quantitative easing, and we expect the yield of high grade bonds to maintain at a very low level.

Other factors that are shaping investment behaviour are the recovery of the U.S market and the concerns around the possible hard-landing of China’s economy. Investors have tried to diversify against this with convergent views that drive the natural flow between these two markets. Many assets are coming over to the U.S, though the net in-flow into China compared to the U.S is still on a positive trend. However, in comparison to the continuously increasing trend, last year was difficult. The figures also show a slowdown in the economy which will continue to impact the market, but I remain positive on the China economy in the long run.

Chido: What types of investments do the private bankers and family offices typically allocate to? Why do you think these are more favoured?

Eva: The very wealthy customers in Asia tend to have multiple private bankers working with them. These private bankers work for a financial institution so the bulk or entire portfolio will be chopped into several smaller portfolios. In these smaller portfolios, investors

1.2 INTERVIEW

Considering the changes to Asian based private bankers’ approach to investing

Interviewer Interviewee

Eva Law Founder, Association of Private Bankers, Greater China

Chido TagariraSenior Publisher

8

Considering the changes to Asian based private bankers’ approach to investing

typically hold traditional core assets like fixed income securities, bonds, as well as blue chips on the equity side. This has been particularly so in the last few years because of the extreme market volatility and the natural desire of people chasing higher rates.

Having reviewed the desk performance of structured solution units in leading players, we have noticed a significant downturn since the bubble, and an echo bounce thereafter. Investors were hard-hit by the structured product in 2008/09 but in 2010, the government also introduced measures tightening the regulation. Since then, we have seen that the market is picking up.

In comparison to other players in the developed market, Asia is less sophisticated, so you can see a lot of asset allocation in real estate and private equity (not private equity funds but in direct investment mode). Asians like to venture their investment into other companies as a minority stakeholder. In some other cases, they invest into the listed company’s share through block trades or getting preference shares. If they want to take control, they sometimes acquire some high growth potential companies. They bet on their family business, so they want to take control, and this is generally what a family office does when they are acting like an institutional investor. In these cases, they go for mergers and acquisitions.

Many Asian wealth owners also have a special interest in infrastructure and commodities related projects.

Over the past 18 months, we have noticed a trend amongs Asian investors where the richest gained enormous interest in venture capital investment because of Jack Ma (founder of Alibaba)’s great success. They are regretting missing the opportunities 10 years ago when Jack was desperately seeking funds. In order to identify undetected opportunities, many wealth owners have approached us to source ICT related venture capital

investments, but the investment amount was not that significant as they were all well aware of the risks embedded with these investments.

In mid-2014, a lot of the super wealthy started to take action. Decisions have been made more quickly and more money has been allocated to the ICT companies, should they regard them as diamonds in the rough. Both private and investment bankers were happy because clients kept asking them to search for more opportunities. This is a big change because in the past, many of the ultra-wealthy used to place a very controlled exposure, or completely stay away from these asset classes.

Chido: Why do you think this has happened?

Eva: The ultra-wealthy are entrepreneurs who have enjoyed great success in generating money from their businesses over the past 2 to 3 decades. However, they also saw that the internet was transforming the market and discerned clearly that their businesses also needed a transformation or makeover. Placing allocations into ICT companies is on one hand their private investment seeking a fast-leapt or exorbitant-soared return, whilst on the other hand, being the shareholders sitting on the board, they want to get access to insider information that might be a key learning source for renovating their own businesses.

Chido: Do you feel that over the next few years some of these investments will be changing?

Eva: Guessing is a hard game and the investment allocation for ultra high-net-worth individuals (UHNWIs) depends upon their unique preference

as well as what is coming up in the market. Many emerging wealth investors will chase whatever the latest trend is as they are not very mature and the less sophisticated investors like to follow the crowd, which means that they could easily forget their own objectives or limitations. They are also influenced by their private bankers to a considerable extent.

Not many UNHWIs or family offices in Asia who have their own investment management committees or teams can manage the investment in a very systematic approach. You cannot compare or benchmark their investment operation with an established asset manager, pension fund or any other private equity house.

Within the office, the key-man dominates the decision making. Many hired investment professionals prefer to act in a way to please their bosses, so they observe what the patriarchs want and have a higher tendency not to follow the science for professional investment management decision making but rather the will of the key-man. This is probably attributed to the Asian culture where they regard themselves as subordinates rather than professionals when they deal directly with their bosses.

As the investment decision is presently managed by the first generation, the aforementioned style of investing won’t change a lot until the next generation really takes over.

Chido: Have there been any regulations that have influenced the

“Asian wealth owners have a special interest in infrastructure and commodities . . . ”

9

Considering the changes to Asian based private bankers’ approach to investing

types of investments that private bankers allocate to?

Eva: Not on investing, but there have been some that have had an impact on account opening processes such as AML (anti money laundering) regulations that affect this process rigorously. There have also been some that impact customers’ experience. Many clients find the account opening process is stalled due to cumbersome compliance and control checking.

For UHNWIs and family offices with substantial assets investing in pension funds or those who own private foundations and appoint external managers, they struggle in seeking alpha. The low interest rate environment posed a challenge to traditional investment and forced the managers to exploit alternative asset classes. However, regulations like disclosure on fund expense ratio or total expense ratio drive customers’ attention to focusing solely on the cost. The use of alternative investment inevitably raises the cost and prompts resistance from investors. Global pension funds that allocate monies diversely into offshore markets are likely be affected by the myriad of regulations shaping up in these different regions.

For example, in Switzerland, because of the regulations introduced, the director of a pension house who is ultimately responsible for their investment act is less willing to approve exposure or allocation to risky asset classes or make any mistakes. In addition, many regulators also launched new legislation and regulations to prohibit deceit, misrepresentation and other fraud. Though the process is stressful, it is good for the market and the investors as sustainable development can only be nurtured in a healthy ecosystem.

I also predict that there is an upcoming trend where UNHWIs may buy into the discretionary portfolio management services (DMS), though Asian investors

have exhibited a clear preference for maintaining control in the past. There are a number of reasons behind this. Private bankers and registered investment advisers are pushing these services aggressively. Since 2014, the major banks and big names were pushing DMS and many marketing dollars have been spent, so results must be generated. In addition, private bankers are now actively discussing the succession management and wealth planning with their clients. Ample time is allocated in the discussion about the structure, design, and the legitimate tax minimisation. In this situation, the time left for deliberating the investment arrangement is trimmed, thus, DMS is becoming a good quick fix solution.

Chido: Are there any other trends that you see coming through?

Eva: In terms of the outlook, the possible asset class that will come into this space and attract institutional money in Asia is commodities as this is something that Asian investors like to invest in. Gold and oil prices have dropped significantly. In the past few months we have seen ongoing acquisitions and dynamic dialogue about acquiring mining sites and investing into resources related projects.

In 2015, many deals will be concluded as there are many already in the pipeline. Asian investors will also start investing in equity because people believe that the market is recovering so they will place more exposure in equities. Part of the whole pie will be assets that generate stable return, so fixed income has an unshaken role. However, the low yield environment gives China a hard time and turns investors’ interest towards senior loans, subordinated debt by banks or high

dividends paying stocks that people traditionally liked to invest in.

Real estate will stay neutral as some markets have already reached crazy prices and the tax issue also means that investors need to consider not only the asset appreciation, but the need to pay the taxes out. There are still opportunities in real estate, not just in the UK or the U.S, but in other regions, for better returns. There is more interest in agriculture related and commercial real estate. These will be the areas that the institutional and ultra-affluent investors will want to invest into.

Chido: Thank you for sharing your thoughts on this topic.

“investors will also start investing in equity because people believe that the market is recovering . . . ”

10

Chido Tagarira: What types of investments do you mostly allocate to?

Ritu Arora: We are a life insurance company that mostly invests in domestic debt and equity markets. We are restricted from making investments in foreign currency or foreign assets. Hence, all of our investments are Rupee (INR) denominated Indian investments.

Chido: What are the restrictions?

Ritu: There are regulatory restrictions in India on life insurance companies holding foreign currency assets and overseas investments.

These restrictions are not unique to India; other Asian markets like China and Malaysia also restrict life insurance companies from making overseas investments.

As a developing economy, the country has large capital investment requirements. So insurance plays an important role in both mobilising small savings to build financial assets and in capital investments.

Chido: How have your investment strategies evolved over the last 5-10years? Have you moved away, or towards, any specific types of investments?

Ritu: In India, life insurance was opened to private companies about 14 years back. Over these years, the product mix has evolved significantly and the investment strategies have evolved accordingly too. The products now include a healthy mix of non-participating products, unit-linked

products, participating products, pension and general annuities. The traditional participating and non-participating products had very limited equity exposures, were categorised as “Held to Maturity”, and the investment strategies were largely guided by asset liability matching (ALM).

Over the years, with the change in product mix, equities have become a significant part of insurance companies’ portfolios. Unit-linked debt funds, which are marked to market daily, focus on returns linked with moving interest rate curve. Unit-linked products have significantly changed the investment strategy of insurance companies.

What has not changed is our inherent philosophy of being long-term investors, keen to generate consistent returns and capital appreciation for our policyholders. We continue to believe in running a balanced portfolio of high quality bonds and equity.

Chido: Given the constant challenges of trying to balance risk and return, how do you decide when it is suitable to add or reduce risk?

Ritu: We are fairly structured in our approach and work within the framework defined in our investment policies. The governance structure is elaborate and enjoys the oversight of the board of directors who approve policies and mandates. The mandates, risk parameters, and benchmarks are well defined and provide guidance. We have a team of highly qualified fund managers and analysts who help us identify good investment opportunities. We have flexibility

within the mandates to make changes to the portfolio composition.

Furthermore, we annually define, review, and adopt a risk appetite statement which defines our appetite around credit risk, market risk, liquidity risk, counterparty risk, etc. We also use sophisticated risk tools and simulation tools.

Chido: Aside from the regulations that you mentioned earlier that restrict you from investing overseas, what other regulations have had an impact on your investment strategy?

Ritu: We are guided by our investment policies and the best practices of our 3 shareholders. We also leverage on the global experience of HSBC Insurance. Our policies and mandates, in addition to regulations, provide us with a solid framework which ensures that we meet the commitment made to policyholders.

Chido: Are there any other factors that influence your investment strategies?

Ritu: As a life insurance company, our products and liabilities are long-dated. Debt investments accordingly are concentrated at the long end of the curve. This end of the curve is not the most liquid or deep, and offers relatively fewer investment opportunities.

Presently, insurance companies’ assets under management are concentrated between debt and equity related assets which clearly indicates an unfulfilled space for alternative assets as a portfolio diversification and

1.3 INTERVIEW

An Indian based life insurer’s perspective on the evolution of investment strategies

Interviewer Interviewee

Ritu Arora Chief Investment Officer, Canara HSBC Oriental Bank of Commerce Life Insurance

Chido TagariraSenior Publisher

11

An Indian based life insurer’s perspective on the evolution of investment strategies

yield-enhancement strategy. Although regulations have been opened for facilitating such investments, the options available are pretty much limited from a quality perspective.

Chido: Is infrastructure on your radar?

Ritu: Yes very much so. As we have long-dated liabilities, any investment opportunity which can generate long-term cash flows is appealing. We already have significant investments in bonds and debt issued by infrastructure companies. I would expect the allocation to increase further in the future. Insurance companies have been large investors in infrastructure companies and projects in countries like Australia.

We expect Real Estate Investment Trusts (REITs) to also be an attractive investment option for insurance companies in India.

Chido: So the future investment trends will be a move towards infrastructure and real estate?

Ritu: In India, there will be significant focus on building infrastructure over the next few years, and I would expect insurance companies like ourselves to participate by investing in the same. REITs, derivatives and real estate as investment options will also become more popular.

Chido: Are there any final comments on your investment strategy?

Ritu: We are committed to delivering consistent performance in all our portfolios in line with the defined benchmarks. The approach is very structured, with a well-defined strategy and risk parameters. The idea is to build a portfolio for the long-term, comprising of good quality bonds and equities which helps us deliver consistent strong performance over many years.

Chido: Thank you for sharing your thoughts on this topic.

“any investment opportunity which can generate long-term cash flows is appealing. ”

12

SECTION 2THE VALUE OF DIVERSIFICATION

How can exposure to alternatives enhance investment portfolios and help to generate consistent returns?

2.1 INTERVIEW

13

Chido Tagarira: In your view, what are the popular asset classes that Asian investors tend to favour? Why do think that is?

Rahma: For pension funds like us who manage assets against certain liabilities, of course liability matching assets such as domestic bonds - that have similar duration to our liability duration - still make up a major portion of our risk portfolio. This is to minimise the downside risk on surplus between asset and liability which is a major concern for our plan sponsor.

To manage risk better, however, we need to be allowed to invest in some derivative instruments for hedging purposes given that there is currently no zero coupon government bond whose duration is close to our liability duration, especially for the long end ones.

For return enhancement purposes, we rely mostly on the domestic equity asset class as we are prohibited from investing offshore. Although, in some neighbouring countries, institutional investors are already allowed to invest offshore.

Chido: So it is just domestic investments that make up your current allocations?

Rahma: Our risk portfolio basket consists of domestic government and corporate bonds, but with much shorter duration in comparison to our liability since, as I mentioned earlier, there is no zero coupon bond whose duration is close to our liability duration. Therefore, by having quite a long duration gap between asset and

liability, our current surplus is still quite vulnerable to interest rate movement.

Our return portfolio basket mostly consists of domestic listed equity, a very small portion of direct property and private equity. Current regulations prohibit us from investing offshore and there are internal as well as external constraints in investing in alternative investments. However, the agreement among ASEAN countries to enter the ASEAN Economic Community that requires member countries to open their investment boundaries may open up an opportunity where regulation will allow pension funds to invest offshore. This would enable us to diversify our return portfolio toward offshore equity investments, subject to our plan sponsor’s risk appetite, our competence, as well as our capacity.

Even though our risk free rate in Indonesia is relatively high in comparison to neighbouring countries, investing in selected sectors or stocks might be worthwhile given that the current domestic equity market capitalisation is quite low, as well as the depth. This means that we are exposed to the risk of investing in overvalued and undervalued assets due to limited opportunity, as well as liquidity.

Our market cap to GDP ratio was 45.3% in 2012, much lower than other countries for example the Philippines 105.6%, Thailand 104.7%, Singapore 144.3%, and Malaysia 156%.

Some multinational fund managers that operate in Indonesia are preparing to capitalise their networks to sell an offshore fund.

Chido: What would it mean for your portfolio if you were able to invest offshore?

Rahma: If, and when, our regulator and plan sponsor allow us to invest offshore, we will have to review our asset allocation policy that is expected to reach the optimal risk/return trade-off considering the new investable asset class. This will mean that we have to modify our investable efficient frontier curve by adding offshore equities as a new asset class based on expected return, risk, as well as correlation coefficiency among those asset classes. So we have some homework to do before getting approval from our plan sponsor, aligned with their risk appetite.

Chido: What role can alternative asset classes (those that are not bonds or equities) play in an investment portfolio?

Rahma: As pension funds are long-term investors, they do not demand as much liquidity as other investors, so alternative investments such as private equity and direct property can actually provide illiquidity premiums to enhance our return portfolio. By not being exposed to price-earnings ratio volatility, it could also add the diversification benefit to our portfolio and reduce the overall risk of the portfolio.

We also have a desire to increase our exposure to alternative investment and implement the Yale Model. But, as I mentioned earlier, there are still a number of external as well as internal constraints to overcome. These include limited internal competency and

INTERVIEW

How can exposure to alternatives enhance investment portfolios and help to generate consistent returns?Interviewer Interviewee

Siti Rakhmawati (Rahma) Head of Investment Analyst, PT Telekomunikasi Indonesia Pension Fund

Chido TagariraSenior Publisher

14

How can exposure to alternatives enhance investment portfolios and help to generate consistent returns?

capacity which needs to be improved, and the fact that the alternative investments industry is not quite established here as there are very few limited partners, hedge fund managers, financial advisors and venture capital managers that are accepted by institutional investors here.

There are also varying mind-sets amongst our stakeholders about the nature of this asset class. For example, investing in a listed company versus unlisted pre-operating company; the two investments are certainly quite different in terms of the probability of the loss or tail risk, the time horizon needed, operational risk, valuation risk, liquidity risk, fraction/concentration risk, cost of investing (due diligence cost, valuation cost, cost of managing assets), etc.

Chido: Which alternative asset classes, if any, would you consider including in your investment portfolio?

Rahma: Subject to the improvements in our internal competence and capacity, our stakeholders’ mind-sets toward specific risk of alternative investment, as well as the readiness of support from other related professions (advisors, valuers, etc), we would consider direct property as we have a demographic bonus with a fairly large, young population. So the demand for property, as well as the price, of property assets will tend to increase.

We would also look at private equity or medium-term notes in infrastructure project since Indonesia infrastructure is quite underdeveloped.

Derivative instruments could also be interesting for hedging purposes, especially to hedge interest rate risk, since it would be costly to buy the long end coupon government bond available in the market in order to reduce the duration gap between asset and liability.

For offshore investment, if already allowed, we would prefer listed equity to other asset classes. The reason behind this being that the risk of investing in listed equity is lower in terms of liquidity risk, operational risk, concentration risk as well as transparency risk. The cost of investing is also lower (valuation cost, due diligence cost as well as cost of managing assets).

Chido: Given the constant challenges of trying to balance risk and return, how do you decide when it is suitable to add or reduce risk?

Rahma: You would add risk if the plan is still underfunded; the member age is quite young so the time horizon is quite long; our sponsor financial condition and business is quite strong which means they can afford the additional contribution to the plan if investment returns are below the expected rate; and if the economic cycle is in the expansionary phase so we could propose the ‘flight from safety’ strategy.

Vice versa, you would reduce risk if the plan is already in surplus where the priority would be to maintain surplus, the member age grows older so the investment horizon become shorter; our sponsor financial condition and business deteriorating so their ability to pay additional contributions to the plan also diminishes; and if the economic cycle is in the contractionary phase so we should propose “flight to safety” strategy.

Chido: Thank you for taking the time to share your views on this topic.

“Derivative instruments could also be interesting for hedging purposes, especially to hedge interest rate risk. . . ”

15

SECTION 3THE ASIA REGION FUNDS PASSPORT REGIME

Expectations for the Asia Region Funds Passport regime3.1 INTERVIEW

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Chido Tagarira: What were the drivers behind the introduction of the Asia Region Funds Passport regime?

Manuel Gaite: The idea of an Asia Region Funds Passport (ARFP) is envisaged to provide an internationally agreed framework to facilitate cross border marketing of managed funds across participating economies in the Asia region. Here we are talking about the collective investment scheme that could also facilitate funds from the Asian region that are being marketed in Europe by way of perhaps an Asian-European mutual recognition agreement.

The main drivers behind the ARFP are that it is envisaged to create a better integrated financial market in the Asia-Pacific region by breaking down some of the barriers between economies; to have more investment across the Asian region; to boost regional trade in financial products; as well as to create an investment outlet that is similar or comparable to the European UCITS.

Chido: Is it a similar structure to UCITS?

Manuel: It is similar in the way it is structured with the only difference being that the ARFP carries different currencies as opposed to the single European currency. In Europe there is the EU structure whereas, here we don’t have a similar political structure.

Chido: How does the ARFP compare to the Asean Collective Investment Scheme and the Hong Kong-China Mutual Recognition Scheme?

Manuel: They are very similar. The only difference is the scope of the application of these schemes and the members of the different economies that participate in the scheme.

Chido: What do you anticipate will be the impact of the ARFP on the fund managers in the member states, and consequently their investors?

Manuel: Fund managers will be able to offer a single fund across multiple markets, and the resulting larger client base will help to grow the fund size sufficiently to realise economies of scale. It also means better fund performance in the form of higher returns for investments with a lower degree of risk. This will also create greater global competitiveness within the Asian fund industry.

The ARFP can introduce foreign expertise, competitive pricing, higher standards of disclosure and performance to local funds. This, in turn, will promote efficiency in the local fund industry.

For the investors, this would mean having direct access to offshore funds and in the process, eliminating the extra layer of fees and commissions charged by local operators. It will offer a broader range of foreign products to choose from which will enable investors to obtain optimal fund performance through a diversified portfolio because spreading investments across different independent jurisdictions can eliminate a large part of the domestic economy risk.

Chido: Will there be a review of the regime to address the concerns around tax and currency issues?

Manuel: We first started discussing the ARFP 4 years ago and since then, we have been in touch with fund managers informally as we were crafting the rules that would govern the ARFP. In the first quarter of 2014, we had a public consultation with the different stakeholders here in the Philippines and the fund managers expressed apprehension considering the small size of the local fund management industry in comparison to those in other Asian economies.

That is not to say that they are not interested in the passport regime. They admit that the cross border scheme is a challenge for them, but it would also allow them to improve their craft and consider steps or strategies to compete with their counterparts in the other economies.

The fund managers have expressed the importance of harmonising regulatory differences, such as tax treatments, across economies. They expect the passport regime to reduce administrative costs in moving across borders. Under the framework, participating economies shall ensure full disclosure of their respective tax and other regulatory requirements on collective investment scheme which will be considered by managers and operators who would be interested in availing the fund passport mechanism.

In the beginning, it will be a regime of full disclosure of its different treatments and then over time, as we navigate through other rules, we can

INTERVIEW

Expectations for the Asia Region Funds Passport regime

Interviewer Interviewee

Manuel Huberto B. Gaite Commissioner, Securities and Exchange Commission, Philippines

Chido TagariraSenior Publisher

17

Expectations for the Asia Region Funds Passport regime

harmonise the regulations relating to the cross border transactions of funds.

Chido: Is it a feasible task to be able to harmonise these regulations across so many jurisdictions?

Manuel: In the case of Hong Kong and China, they are doing a mutual recognition scheme. Ideally you can have different economies agreeing on a common framework, but that might take some time. So where we agree, we have common rules. We also agreed on when the home rules and host rules will apply.

For the simple issues, we have agreed to have common rules. For the more complex issues, we have agreed to tackle them in the future. We have recognised issues where the home and host rules will apply, and we have a mechanism for discussing any issues which may arise once the ARFP goes on stream.

Chido: What does the timeline look like?

Manuel: We are almost at the end of the discussions regarding the rules. Regarding the timeline, we are fine-tuning the rules and are now going through the second public consultation. By the end of April 2015, we will be able to have the result of the public consultation and then meet in May to discuss the final draft of the rules.

We are looking to sign the Multilateral Memorandum of Understanding (MMOU) for the passport rules possibly at the end of 2015. This project is under the auspices of the finance minister process of Asia-Pacific Economic Cooperation (APEC). As the APEC meeting for 2015 will be in Manila in November, the plan is to have the signing of the MMOU about that time.

Chido: Do you have any comments regarding the currency issues?

Manuel: We have not yet discussed that in much detail. As far as the tax issues are concerned, it will be a full disclosure of the tax regime that any investor or fund manager will encounter in any of the jurisdictions.

Chido: Thank you for sharing your thoughts on this subject.

“We also agreed on when the home rules and host rules will apply. ”

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