assets are above 150% their respective regions¡¯ GDP figures. For the three markets in Asia which we highlighted above, Korea has the highest ratio at 78% and China the lowest, with just 17%. From this perspective, there appears to be significant potential for the expansion of the institutional investor base in emerging markets. ? China, in particular, may see rapid growth in its institutional asset base, as robust economic growth will be coupled with government initiatives to expand pension coverage. The Chinese government aims to achieve full national coverage of the population with its social security system by 2020, and we expect more accounts in the social security system will be allowed to invest in equities in the future. (See Global Economics Paper No: 191, China Savings Rate and Its Long-term Outlook, October 2009. Emerging market institutional investors could have an equity asset base of around $30 trillion by 2030. As a rough approximation of the potential size of EM institutional equity holdings in two decades, we note that DM institutions tend to own between 40-50% of the equity assets in their respective markets. In more mature emerging markets like Taiwan and Korea this ratio is about 35%, whereas local institutional ownership in the BRICs is no more than 15%. If overall EM institutional ownership rises to the lower end of the current DM band by 2030 (i.e. 40%), then this would imply approximately $30tr of equity assets given our projected $80bn EM equity market cap.
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Exhibit 32: EM countries have had high savings rates, in part driving the rapid increase in people¡¯s wealth Savings as % of GDP, average over 1991-2009
(%) 40 37 35 32 30 29 27 25 21 20 20
Exhibit 33: EM households allocate a smaller portion of financial assets to equities compared to their DM peers Equity and mutual fund as % of household financial assets
Equity and mutual fund as % of household financial assets
US EU-27 (inc. UK) Korea Australia Taiwan China* Japan
40% 35% 30% 25%
US
20%
EU (inc. UK)
19
18
15%
Australia
15
10% 5%
Taiwan China Japan Korea
10
NICS Africa G3 Developing Asia Western Hemisphere Middle East CEE CIS
0%
1992
1993
1994
1995
1996
1997
1998
1999
2002
2003
2004
2005
2006
2007
2000
Note: Savings is calculated as the top-down macro aggregate savings, including savings of households, corporate and government. See Global Economics Paper No: 197: Baby Boom and Ageing, Property Boom and Bust: Why Korea Will Not Follow Japan¡¯s 1990s Experiences, June 2010.
Note: Data on flow of funds account (stock basis) is not available for China. Figures above for China are showing the proportion of income (flow concept) going into equity and mutual funds.
Exhibit 34: US had the most rapid increase in their equity/ mutual fund allocation in the 1990¡¯s Equity and mutual fund as % of household financial assets
Equity & mutual fund as % of household financial assets 40%
Exhibit 35: A younger population in EM should support a shift towards more equities as wealth increases Proportion of population under 40 years old
% of populations Philippines India 77% 72% 71% 70% 68% 67% 61% 60% 55% 54% 54% 53% 52% 51% 46% 44% 0% 20% 40% 60% 80% 100%
35%
Malaysia Indonesia Brazil
30%
World Thailand
EM
(avg = 65%)
25%
China Korea
20%
USA Australia Russia
15%
1990 - 2000: rapid rise in equity/ mutual fund allocation in the US
Singapore UK Hong Kong
DM (avg = 50%)
10%
Mar-76 Mar-00 Sep-74 Mar-79 Mar-82 Mar-85 Mar-88 Mar-91 Mar-94 Mar-97 Sep-01 Mar-03 Mar-06 Mar-70 Mar-73 Sep-77 Sep-80 Sep-83 Sep-86 Sep-89 Sep-92 Sep-95 Sep-98 Sep-04 Sep-71 Sep-07 Mar-09
Japan
Exhibit 36: Institutional funds in emerging markets are still early in their development stage Institutional fund AUM as % of GDP
Institutional AUMs as % of GDP 250 230
Exhibit 37: Institutional funds in emerging markets own a lower percentage of the overall market cap Estimated local institutional ownership of equities
Local institutional ownership of equities 60% 54% 51% 50%
200 176 154 150 137
40%
40% 37% 37% 35% 34%
30%
100 78 68 54 50 50 27
20% 14% 10%
22 17 5
9%
9% 5%
0
Australia Taiwan US Malaysia Japan Korea Brazil India Europe Thailand Russia China
0%
Australia Malaysia Taiwan US Korea India Japan Europe Brazil Russia China
Note: In this paper institutional asset is defined to include pension funds, insurance assets and mutual funds, to the extent data is available from public sources. For local institutional ownership, the following proxies are used for countries without official exchange data release: for Europe, India and Russia, we estimate using equity AUM of institutional funds as % of market cap; for China, we aggregate data from the top-10 holder classification for individual stocks, excluding legal person shares (mostly holdings of corporates); for Brazil, this is proxied from the owners breakdown of deposited securities; our Australia numbers source from a survey by Goldman Sachs & Partners; our Malaysia numbers are proxied by the turnover breakdown. China in these two exhibits refers to China domestic, for both market cap and size of institutional fund AUMs.
Source: CEIC, IMF, local stock exchanges and regulatory authorities, OECD, United Nations, Wind, Goldman Sachs Global ECS Research estimates. Issue No: 204
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Impact from an expanding institutional base
The development of the local institutional funds complex within the emerging markets will likely impact the behavior of their equity and other capital markets. From a valuation perspective, a deepened institutional ownership base may be supportive of market valuations, arguably due to home country allocation bias, or restrictions from fund mandates. Particularly during downturns, investors that are required to keep a certain portion of their portfolio invested in equities may provide more secure ¡°floor¡± valuations within the market. Currently, a larger portion of investors are foreigners, hedge funds, and retail investors, which anecdotally appear to be more flexible in cutting equity exposure more rapidly and sharply than a mutual, pension, or insurance fund might be able to do. An increasing dominance of local institutional players may also lead to changing dynamics from a volatility perspective. Looking at the past five years of trading patterns from around the globe, we find that markets with a high institutional ownership base, which tend to be the developed markets, also tend to have lower realized volatility. Perhaps the increasing influence of local institutional investors in the emerging markets may lead to a reduction in their equity market volatility, although we also note that the link between lower volatility and economic development may be due to lower ¡®fundamental volatility¡¯ in more mature economies.
Exhibit 38: Higher institutional equity ownership is associated with lower equity market volatility Realized volatility vs. local institutional ownership of equities
45
Average annual realized volatility (2005-2010)
40
RU
BR
35 CN 30 IN
Higher institutional ownership Lower equity market volatility
25
Lower institutional ownership Higher equity market volatility
KR TW
JP
20 AU 15 MY 10 0% 10%
EU
US
20% 30% 40% Local institutional ownership of equities
50%
60%
Source: Federal Reserve, ICI, local stock exchanges and regulatory authorities, OECD, Wind, Goldman Sachs Global ECS Research estimates.
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3. Implications for investors, financial intermediaries, corporates
We have made the case that emerging markets are likely to grow substantially in absolute size over the coming two decades and become a much larger share of the global market cap and index pie. In turn, we expect this to encourage significant flows from DM savings pools into EM equities and to spur (and in part be driven by) the continuing institutionalization of EM savings pools. Below, we outline some of the implications that these developments may have for investors, financial intermediaries and corporations.
Investors- return opportunities (with caveats); resource allocation
?? Potential attractive absolute and relative returns from EM. Over the long
run, listed corporate profits correlate well with underlying economic growth, and profits (along with dividends) are the main drivers of long-term returns. As we previously noted in Exhibit 17, the main contributor to the growth in market caps that we project over the next 20 years is likely to be earnings; valuation and FX changes may enhance or impede this, but the locomotive is real profit growth. Our long-term economic growth projections for emerging market economies thereby suggest that investors have an opportunity to earn attractive returns- in absolute terms and relative to DM markets- from investing there.
?? Two caveats- entry points matter; earnings growth not wholly tied to
domestic GDP. That said, we highlight two important caveats.
¨C Avoid overpaying for growth. One of the key mistakes investors
continually make is overpaying for future growth opportunities. This is true in developed markets (e.g. the late 1990s tech bubble) as well as in the many boom/bust episodes in emerging markets. In Exhibit 40, we show the rolling 5 and 10 year DM and EM price returns over the past nearly three decades. There has been a strong positive correlation between long-term returns and earnings growth, particularly in EM, and a negative correlation between returns and starting valuations, notably in DM. Clearly, entry points matter, even if the underlying fundamentals are strong. We note that EM valuations are presently moderate in both absolute terms and relative to historical ranges.
¨C Concentrate on sources of revenue. Equity markets are not necessarily a
simple reflection of their underlying economy. Increasingly, listed companies have sources of revenue outside their listing domicile: for example, over 30% of the S&P500 revenues are from outside the US and over 60% of Taiwan¡¯s listed corporate earnings come from the tech sector which mostly manufactures and sells its products outside of Taiwan. Investors must therefore be conscious of how they obtain exposure to the underlying growth opportunities in EM (see Global Portfolio Strategy: The BRICs Nifty 50: The EM & DM winners, Nov 4 2009).
?? Benchmark selection. As we previously noted, there are substantial
differences between the weight of emerging markets in the MSCI AC World index and their share of the global economy and contribution to its growth. The trend towards using alternative benchmarks, such as GDP-weighted indices, may gather pace.
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?? Strategic allocation of resources to EM. From an operational perspective,
the structural opportunities in EM imply a greater allocation of resources by investment firms towards these markets. This may include more on-theground presence in order to improve research and trading capabilities, which in turn implies a higher cost base and therefore