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© 2010 The Actuarial Profession www.actuaries.org.uk

Demographic Impact on Investment Strategy

Schroders

Katherine Davidson & Gavin Marriott

28th June 2012

Introduction


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Why care about demographics?

2 © 2010 The Actuarial Profession www.actuaries.org.uk

“ Demographics explain

two-thirds of everything.” - David Foot, Canadian Economics Professor

Consumption GDP Growth

Fiscal Policy

National debt

Current account &

Capital flows

International Relations

Company earnings

Asset prices

Demographics and debt


NPV of fiscal impact of the financial crisis and population aging

0

5

10

15

20

25

0

100

200

300

400

500

600

700

800

Aging Crisis

% of GDP Cost of crisis/cost of aging

Source: IMF (2009)

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Demographics and growth


50

55

60

65

70

75

2000 2005 2010 2015 2020 2025 2030 2035 2040 2045 2050

China Japan United Kingdom United States of America Western Europe

Proportion of population of working age (15-64) %

Source: UN World Population Prospects, 2010 Revision

Demographic trends in the UK (and Overseas)


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2012

The UK is ageing


2050

Source: US Census Bureau

60% growth in over 65s:

from 17% to 24% of total

Male Female Male Female

But not as fast as other countries


0

10

20

30

40

50

60

70

80

19

50

19

55

19

60

19

65

19

70

19

75

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80

19

85

19

90

19

95

20

00

20

05

20

10

20

15

20

20

20

25

20

30

20

35

20

40

20

45

20

50

0

10

20

30

40

50

60

2015 2050

Japan Germany

Spain France

United Kingdom United States of America

China

Old-age dependency ratio Over 65s as a % of working age population

Median age Years

Source: UN World Population Prospects, 2010 Revision

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Due to higher fertility


1.00

1.50

2.00

2.50

3.00

19

70

19

71

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00

20

01

20

02

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20

04

20

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20

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09

20

10

Greece France UK Spain Austria

Replacement rate

‘Lowest low’ fertility

Source: Eurostat

Driven partly by immigration


0

5

10

15

20

25

30

0

2

4

6

8

10

12

2001 2002 2003 2004 2005 2006 2007 2008 2009 2010

Pakistan India Bangladesh Poland Nigeria Somalia South Africa Total (RHS)

% of live births to foreign-born women (LHS)

Source: Office of National Statistics

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But not exclusively


Country of birth 2010 2009 2008 2007 2006 2005 2004

UK 1.88 1.85 1.85 1.80 1.76 1.68 1.69

Outside UK 2.45 2.48 2.52 2.54 2.42 2.44 2.50

Total 5 2.00 1.97 1.98 1.92 1.87 1.79 1.80

0.00

0.02

0.04

0.06

0.08

0.10

0.12

0.14

0.16

19

73

19

74

19

75

19

76

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UK age-specific fertility rates Children per average woman in given age group

15-19

20-24

25-29

30-34

35-39

40-44

Source: Office of National Statistics; Eurostat

Total fertility rate of UK residents by country of birth

Europe: structural challenges

• Working age population in decline. By 2050,

there will be 1 retiree for every 2 workers in

Western Europe

• Potential GDP growth will almost halve.

• Fiscal cost of aging will reach 28% of GDP

p.a. by 2060

• Europe would need 1.4bn immigrants to

sustain its current population structure:

equivalent to the entire Chinese population!

• Structural reforms are a necessity, and will

fundamentally alter investment environment.


Source: UN World Population Prospects, 2010 Revision; European Commission, OECD.

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United States: manageable headwinds

• Most favourable demographic profile

in developed world: ‘country

competitive advantage’

• Higher fertility, especially among

ethnic minorities.

BUT

• Boomer retirements raise possibility

of skills shortage in some industries

• Healthcare system most expensive

in the world

• Unfunded liabilities >$200 trillion.

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USA 2050

-4% -3% -2% -1% 0% 1% 2% 3% 4%

0- 4

10-14

20-24

30-34

40-44

50-54

60-64

70-74

80-84

90-94

100+

Male Female

Source: US Census Bureau, Lawrence Kotlikoff, OECD

Popular misconceptions of demographic trends


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China: size isn’t everything

• China is aging faster than

Western Europe

• 1.3bn people, but the working age

population will shrink from 2015.

Surplus labour likely overestimated

• Wage inflation accelerating

• End of the demographic

dividend will make it harder

to sustain growth

• Distorted sex ratio poses serious

social problems

• Abolishing one child policy

unlikely to have an impact.


0

20

40

60

80

100

2050

2045

2040

2035

2030

2025

2020

2015

2010

2005

2000

1995

1990

1985

1980

1975

1970

1965

1960

1955

1950

Children Elderly

100

105

110

115

120

125

Bela

rus

Hong K

ong

Cypru

s

Bosnia

Sin

gapore

India

Serb

ia

South

Kore

a

Georg

ia

Azerb

aijan

Arm

enia

Chin

a

China’s dependency ratio % of working age population

Males per 100 females at birth 2005-10

Source: UN World Population Prospects, 2010 Revision, Economist

Japan: growing old (relatively) gracefully

• Debt still the highest in the world,

but quirky accounting overstates

the degree

• Healthcare and pension spending

under control: spending per

retiree well below OECD average

• Participation rate for older workers

highest in the world. Flexible ‘re-

hiring’ program limits wage burden

• Still opportunities for investors

as industries emerge and adapt to

serve

older workers.


Source: OECD, ILO (2010)

0

10

20

30

40

50

60

70

80

Canada France Germany Greece Italy Japan United

Kingdom

United

States

Men 60-64 years Men 65 Plus

Economic Activity Rate, %, 2009

Source: OECD, The Economist. Data for men as at 2010 or latest

45 50 55 60 65 70 75 80 85 90

UK

US

France

Germany

Italy

Spain

Greece

Japan

Life expectancy

Effective retirement age

Official retirement age

Retirement age and Life Expectancy

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All BRICs are not created equal

16 © 2010 The Actuarial Profession

www.actuaries.org.uk

-1.0

-0.5

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

China India Russian Federation Brazil

30 35 40 45 50 55 60 65 70 75 80

0

5

10

15

20

25

Brazil China India Russian Federation

Old-age dependency ratio, %

Life expectancy at birth, years

Population growth, %

15

20

25

30

35

40

45

Median age, years

Source: OECD, ILO (2010)

Africa: basket case or breadbasket?

• 50 years ago, Africa was richer than

Asia. GDP per capita in South Korea

was lower than Somalia; now its output

is higher than the whole continent

• 60% of the world’s uncultivated arable

land; rich in minerals, precious metals

and fossil fuels. Sahara could supply

whole world’s electricity

• Coming demographic dividend as

fertility falls

• Lagos and Kinshasa will be bigger than

Beijing by 2025

• McKinsey estimates GDP could double

by 2020; consumer goods market will

be as big as India.



Average GDP per capita (PPP terms)

0

1000

2000

3000

4000

5000

6000

1950

1954

1958

1962

1966

1970

1974

1978

1982

1986

1990

1994

1998

2002

2006

Africa Asia2

Africa’s GDP growth is steadily on the rise*

0

1

2

3

4

5

6

2011-15 2000s 1990s 1980s 1970s

African countries Asian countries Source: Maddison tables, SocGen, UN World Urbanisation Prospects, McKinsey, Economist.

* Excluding countries with population <10m, Iraq and Afghanistan

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Implications for asset class returns and investor behaviour


Demographics and asset prices The ‘Market Meltdown’ Hypothesis

“The words “Sell? Sell to whom?” might haunt the baby boomers in the next century.

Who are the buyers of the trillions of dollars of boomer assets? [They] threaten to drown

in financial assets…” – Jeremy Seigel


24%

25%

26%

27%

28%

29%

30%

31%

32%

33%

34%

19

63

19

64

19

66

19

68

19

69

19

71

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73

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81

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19

0

200

400

600

800

1000

1200

1400

1600

S&P 500 (RHS) Proportion of population age 40-64 (LHS) Source: Thompson Reuters Datastream, Schroders

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Demographics and asset prices The counterarguments


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100

150

200

250

300

1950 1955 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010 2015 2020 2025 2030 2035 2040 2045 2050

Actual Model based on theoretical savings behaviour Model based on actual savings behaviour as observed in data

Projected real stock prices for the US

• In reality, people do not run down their assets as per theory

• Rising saving in emerging markets and capital liberalisation

– Today, 91% of US market cap is owned by domestic investors; by 2050, this could

be as low as 30%.

Source: Academic work including Brooks (2006), Siegel (2007), Poterba (1999, 2004).

Demographics and asset prices Equities versus bonds

Alternatively, pension funds and individuals de-risking may put pressure on equities versus bonds?

- Inconclusive empirical evidence for changing household asset allocation

- Rising life expectancy

- Underfunded plans need higher equity exposure for longer


Company Name Exp'd return % Pension deficit

% of mkt cap

Theoretical equity

allocation*

FirstGroup 7.76% 25.14% 172%

Greene King 7.40% 4.42% 149%

Stagecoach Group 7.38% 7.14% 148%

BG Group 7.30% 0.23% 143%

Tesco 7.30% 5.38% 143%

BP 7.25% 3.84% 140%

Babcock Intl 7.20% 7.58% 137%

National Grid 6.70% 2.43% 106%

Diageo 6.63% 2.24% 102%

BT Group 6.35% 11.48% 85%

Royal Dutch Shell 6.30% 3.14% 81%

Imperial Tobacco 6.14% 3.14% 72%

UK government 6.80% 112%

Source: Citigroup, Schroders.

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Demographics and asset prices Equities versus bonds

• QE-driven bond bubble? Equities cheap vs. bonds, provide inflation protection

• Are dividends the new coupons?


-12

-10

-8

-6

-4

-2

0

2

1970 1975 1980 1985 1990 1995 2000 2005 2010 -12

-10

-8

-6

-4

-2

0

2

4

1970 1975 1980 1985 1990 1995 2000 2005 2010

Source: Datastream, Schroders

S&P 500 dividend yield minus 10yr US govt bond yield

S&P 500 dividend yield minus US corporate bond yield

(Moody’s BAA Seasoned Issues)

FTSE All Share dividend yield minus 10yr UK govt bond yield

Dividend yield spread over government and corporate bonds at record high

0

10

20

30

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60

70

80

90

Mar 03 Mar 05 Mar 07 Mar 09 Mar 11

Open High Low Close

Markets increasingly short-term leading to a structural rise in volatility


0%

50%

100%

150%

200%

250%

1974 1979 1984 1989 1994 1999 2004 2009

% of market cap turned over annually (value traded/market cap)

2 year moving average

Holding periods declining Structural rise in equity market volatility

Source: Datastream, Goldman Sachs Research estimates

% of market cap turned over annually VIX Index

Source: Schroders, Bloomberg

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Opportunities for equity investors


Demographics and investment

“Demography is the most powerful and most underutilized tool we have to understand the past and to foretell the

future.”

David Foot Professor of Economics at Toronto University, Canada Author of “Boom, Bust & Echo: Profiting from the Demographic Shift in the 21st Century”

Yet...

“Investors neglect long-term demographic variables.”

Stefano DellaVigna and Joshua Pollet National Bureau of Economic Research Authors of “Attention, Demographics and the Stock Market”


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Demographic Opportunities

26

Demographic

Change

– Population size

– Age structure

Changing

Consumption

– Consumption

by age

– Consumption by

Income level

Economic Growth

Global Demographic Opportunities


Demographics give long-term investors an edge


Few analysts forecast long-term

earnings

Demographics affects earnings

estimates & valuations, TODAY

0

5

10

15

20

25

Y1 Y2 Y3 Y4 Y5

Number of estimates for each forecast year

A small minority of

analysts forecast

earnings for more than

three years

Company Earnings Consensus Estimates

250

150

50 1 6 11 16

Stronger conviction in long

term earnings growth

estimates due to positive

effect of demographics

Market fails to recognise structural

growth. Company earnings

consistently beat estimates

Positive

Growth

Gap

Forecast Actual

Earnings

Source: Goldman Sachs, Schroders

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Our analysis

• Identify changing patterns

of expenditure and

consumption by

demographic trends

• Screens indicate growth

potential at country,

sector, industry and

stock-level

• Further research on

companies exposed to

the ‘hotspots’ with highest

growth potential.


Source: Schroders

Stock examples –Yum!

• Rising income and young demographic profile increase fast food consumption

• Leading Western fast-food brand in China, similar positions building in other

Asian markets

• Most well-recognised US brand in China and India.


*Source: Schroders Demographics Database.

Please note that this is an estimate of future growth and past events are not necessarily a guide to the future. As at 30 June 2011

• YUM! Brands owns a

worldwide system of

restaurants, with over

37,000 units in more

than 110 countries and

territories through the

five concepts of KFC,

Pizza Hut, Taco Bell,

LJS and A&W.

Understanding Demographic Drivers

Company’s business strategy matches our demographic hot spots

2010-15 CAGR Restaurants and hotels

United States

China

United Kingdom

Indonesia

Vietnam

South Africa

India

Russia

Malaysia

Thailand

Japan

Italy

Where Yum has significant

presence or is focusing on

developing market share

Where Yum has little

or no presence at all

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PE reacts to changes in China Same

Store Sales*…

Stock examples –Yum!


… despite consistent growth in operating

profit

0

5

10

15

20

25

-25%

-20%

-15%

-10%

-5%

0%

5%

10%

15%

20%

25%

Q3 06

Q1 07

Q3 07

Q1 08

Q3 08

Q1 09

Q3 09

Q1 10

Q3 10

Q1 11

Q3 11

Yum! China Same Store Sales

P/E in the middle month of the next quarter

290

375

469

602

738

0

200

400

600

800

2006 2007 2008 2009 2010

Yum! China profit USD mm

*Source: Yum!, Thomson Reuters Datastream

Stock Examples – Unicharm



Diapers Market Trend (Japan)

Adult Incontinence Market (Japan)

190 200 210 220 230 240 250 260

6000

6500

7000

7500

8000

2000

2002

2004

2006

2008

2010

2012E

2014E

2016E

Japan Retail Volume (LHS) Japan Retail value (RHS)

mn units

mn units

¥bn

¥bn

0

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100

150

200

250

0

1000

2000

3000

4000

5000

2000

2002

2004

2006

2008

2010

2012E

2014E

2016E

Moderate/Heavy Volume (LHS) Light Volume (LHS)

Total Value (RHS) For illustrative purposes only and not a recommendation to buy or sell shares

Source: Euromonitor, BofA Merrill Lynch Global Research

Unicharm corporation

is a Japan-based

company mainly

engaged in the

manufacture and sale

of baby care products,

feminine care products

and pet care products.

• Benefits from rising penetration of

diapers and feminine care products in

emerging Asia

• Exposure to aging in Japan via petcare

and health segments.

Understanding Demographic Drivers

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Which all goes to support the fact that …….


Summary


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• Demographic trends have significant explanatory power

• Trends are often misinterpreted or simply overlooked

• Demographics affect asset flows and investor preferences

• If properly understood, can be harnessed to increase

confidence about areas of structural growth and alpha

generation

Conclusions


Questions or comments?

Expressions of individual views by

members of The Actuarial Profession

and its staff are encouraged.

The views expressed in this presentation

are those of the presenter.


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