In many ways Singapore has become a victim of its own success. As a wealthy but fast-ageing society it does not have the luxury of time as it seeks new ways to maintain living standards. How the Central Pension Fund (CPF), as the guardian of its pension system, embraces investment reforms is therefore crucial, argues Gregg McClymont.
Pension systems always reflect trade-offs between adequacy (of incomes), coverage (of the population) and cost (to the public and private sectors). Singapore’s pension system continues to stand comparison with the better systems across the world.
The CPF has done a very good job over the years at balancing some of these imperatives, even as it has taken on further responsibilities beyond retirement – namely for the provision of housing and healthcare.
Among the CPF’s most impressive aspects are the following: high contribution rates by global standards; individuals and employers co-contributing; a self-select option to encourage individual responsibility and choice for those with larger balances; and a basic guaranteed income stream in retirement via CPF Life.
Singapore must grapple with the pressures of an ageing society and lower investment returns.
Nonetheless challenges remain. In common with many countries, Singapore must grapple with the pressures of an ageing society and lower investment returns. By 2050, despite already having a relatively old population, Singapore is expected to have one of the biggest rises in the share of seniors in the world.
Indeed, it will have a higher share of over-65s than Western countries often seen as ageing fast such as Canada, France, the UK, Australia and the US. As a developed nation with high per capita incomes and a sophisticated economy it is no surprise that Singapore finds itself in this position.
The improvement in life expectancy at birth has been dramatic.
There are four policy levers which commonly can be manipulated in response to the ageing challenge: higher fertility rates, increased immigration, expanded labour market participation among older workers, and the raising of entitlement ages.
Developed nations have found the first very difficult to alter. Singapore’s total fertility rate (TFR) has fallen to around 1.242, way below the replacement rate, and despite a raft of financial incentives to couples to marry, start families and have more children.
In fairness, raising the TFR to the replacement rate has been a challenge beyond other nations (Japan very recently is an exception), even though a small rise from a low base can make a big difference to long-term demographic projections. Such a strategy also potentially conflicts with female labour market participation, which, in itself, is part of the solution to an ageing society.
The second lever – increased inward migration – can also be challenging. Modern Singapore was built by migrants and their descendants. But this openness has been tested recently, as the government has acknowledged. Lack of space means it can’t accommodate ever more people without endangering the quality of life that Singaporeans have worked so hard to enjoy.
Singapore has made huge strides in terms of the third and fourth policy options. Labour market participation rates have increased substantially. Indeed, Singapore is a world leader in the rate of growth of participation across both the 55-64 age group and the 65+ group.3
Still, there is more room to run. As life expectancy continues to climb, labour market participation will need to run well into the 70+ age bracket. As of 2015 only 16% of man, and 9% of women, above 70 years of age, were in the workforce4.
The success of Singapore in extending the average lives of its citizens also necessitates increasing the entitlement age for CPF benefits. In July 2017 Singapore is therefore due to increase its re-employment age. Although the retirement age is 62, companies must offer re-employment to eligible workers up to 65. This is due to be increased to 67.
Yet while a welcome measure, other countries have gone further. The UK’s state pension eligibility age will rise to 67 by 2028, with further rises linked automatically to longevity. The UK’s guiding principle is that individuals can expect to spend no more than 1/3 of their lives in retirement. Applied to Singapore, this principle would demand a steeply rising retirement age.
In terms of the ageing society, Singapore may be a victim of its own success in building a healthy, wealthy nation. But ageing is only one half of the equation. What about investment returns?
Volatility and risk
Ex-White House adviser Mohammad El Arian recently referred to the global retirement system as ‘Titanic’-like, given recent low rates of return. He warned of desperate pension fund managers chasing the kinds of returns needed to meet pension liabilities. The result would be plan members “increasingly being exposed to the threat of losses that cannot be recoupled quickly”.
But this is to confuse volatility and risk. As the institutional pensions expert Keith Ambachtscheer has noted, those invested in schemes like the CPF are investing for the very long term.
The volatility-is-risk assumption is relevant only for older workers for whom sharp market declines can’t be smoothed by regular contributions (and time), and for retirees who (if drawing an income from investments) face the sequence-of-returns risk of crystallising losses.
In contrast, for most of a retirement saver’s lifetime the dominant risk is the absence of sustainable long-term return compounding – that is, possessing cash flows (such as dividend payments) that are not sustainable beyond the short term. Long-term investors know better – and long-term investing is exactly what retirement saving is all about.
Think long term
The answer, for pension savings focused on long-term compounding assets, is not therefore to dial down risk and lower expected returns. It is, as ever, to start investment early and stay invested.
From 1871 to 2014, US stocks and Treasury bonds generated annualised real returns of 6.7% and 3%, respectively, according to Ambachtscheer. However, of that 6.7%, he allows that perhaps one percentage point a year was due to unanticipated upward price valuation of stock earnings and dividends. Strip that out and the amount you could expect to receive from equities falls to 2.7% a year (ie, 6.7% minus 3% minus 1%).
How does that compare to a reasonable forward-looking expectation today? The Gordon growth model (return = income plus capital gain) suggests an annualised real return of 3.6% for stocks and 0.5% for bonds. This implies an expected annualised risk premium today of 3.1% – which is actually higher than the historical annualised 2.7% expectation, concludes Ambachtscheer.
The larger point remains that in the long run equities make sense.
Now, there are some valid objectives that quantitative easing (QE) has distorted the cost of money by pushing down interest rates and thereby invalidated traditional measures of value. Put another way, equities are over-priced. It is a view with which I have some sympathy. But the larger point remains that in the long run equities make sense.
From this perspective, the crucial obstacle is short-termism. It is not, as current fashion suggests, that passive management is better than active, since the latter ‘cannot beat the market’.
In the real world, all participants do not have access to the same information, and do not use that information identically. Passive, including smart beta, is reliant on the quality of public information in order to arrive at an asset price. Active management may overcome this limitation with first hand research.
Long-term investors focused on long-term compounding of assets, with the ability to analyse information acutely, have a genuine advantage. True, there are active managers who hug benchmarks. In a low return environment, that naturally makes costs a focus. But costs should not be an end in themselves. Long term active investors avoid the over trading that explains so much of retail investors’ under-performance.
In conclusion, there is no perfect pension system and every nation’s is shaped by culture, history and individual quirks. Singapore’s desire that citizens must not become dependent on government – the curse of the welfare state, as it sees it – is arguably its most far-sighted aspect.
To sustain that vision means helping citizens achieve the best income in retirement on a sustainable basis. That will require a combination of things. Higher contribution rates (a feature of the latest budget) would seem inevitable.
A good default investment option delivering scale economies and continued self-select choices for those with higher balances and knowledge would add flexibility.
A focus on the long term ideally would promote the benefit of compounding. Both public and, increasingly, private markets can provide that (bringing diversification too). Last, it might be desirable to close anomalies such as investments in single stocks that the CPF Investment Scheme (CPFIS) permits.
This article originally appeared in Business Times on 30 March 2017
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