By Jessica Alsford
That we are facing a major and unavoidable shift in the world’s demographics – the ageing of the global population – is not disputed. The drivers of this megatrend – falling fertility and rising life expectancy – planted their roots more than 50 years ago and cannot be unwound.
In 1985, for every person turning 65, there were 10 new people of working age. By 2040, for every incremental person aged over 65, there will be less than one additional person in the 20-64 age groups. The significant challenges for society, governments and companies are clear to see. But what does it mean for asset prices in the coming years?
Investment theory suggests that as individuals reach retirement their risk appetite reduces, implying a switch into lower-risk assets, such as from equities to bonds. In addition, the need to finance retirement often leads to retirees drawing down on their accumulated assets. If we position this theory against the current backdrop of an ageing population, then it seems logical to predict a negative impact on asset valuation – particularly higher risk assets such as equities – as a larger group of retirees sells assets to a smaller group of savers.
Academic studies, such as Davis and Li (2003)1 concluded that an increase in the percentage of the population aged 40-64 has a positive impact on real asset prices (both equities and bonds). Our own research suggests that there is indeed a link between the valuation of US financial assets and the percentage of the US population in the key saving age group of 35-59 years. In addition, changes to disposable income and asset prices may make asset transferrals from old to young more difficult. Asset price appreciation during the 1980s and 1990s helped to increase the wealth of the baby boomers – the group that is now starting to retire.
However, for today’s main group of savers, constraints in disposable income and less affordable house prices may reduce the availability and timing of investment into financial assets, exacerbating the negative impact on asset prices.
However, there are a number of other factors that may temper the negative effect. As life expectancy continues to rise, uncertainty around the length of the retirement period increases, which could slow the rate of financial asset selling. Furthermore, financial assets are not equally owned across the group of retirees: the top 10% of UK households own 44% of total wealth. The main owners of financial assets are thus less likely to need to sell them to fund their retirement.
Global financial assets have also become much more internationally invested over the last 30 years, reducing any correlation between an individual country’s demographics and asset valuations. Another factor in the magnitude of any asset sale is the desire of individuals to leave some assets for their heirs to benefit from.
We also have evidence that the switch from bonds into equities has already begun. Data from Towers Watson shows that between 2006 and 2012, the seven largest pension fund markets globally decreased their exposure to equities from 50% to 41% on average whilst exposure to bonds increased from 32% to 37%. While the motivation for this switch may have been macro led, we think it plausible that demographics may prevent a full reversal of this trend as buying signals for equity markets improve.
The outlook certainly doesn’t appear positive for asset price performance on demographic trends alone. However, uncertainty over the length and type of retirement, asset concentration and bequests may reduce the downside. We have already seen a move away from equities into bonds and other assets.
Jessica Alsford is head of Morgan Stanley’s sustainable and responsible investment research team in Europe
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