"Funding Unfunded Pensions: Governance and Investments of Asian Reserve Funds" investigates the four largest pension reserve funds in Asia-Pacific (those of Australia, China, South Korea and Japan) which together account for over 766 billion euros in assets under management. Due to their sheer size, these funds have an important influence on global financial markets and national economies. Given the ageing populations the professional management of these funds is critical for the sustainability of public pensions.

Many countries around the world have introduced pension reserve funds (also known as sovereign pension or demography funds) in order to fund future liabilities and cushion the impact of ageing populations on public pension systems. The funds pre-fund part of future pension payments so that when the ratio of employees to pensioners becomes unfavourable, the pensions system can draw on accumulated capital to pay benefits instead of being purely dependent on contributions. Their importance is illustrated by the fact that three of the world's four largest pension funds are pension reserve funds.

The four Asian funds studied in the report, whilst differing in their maturity, all demonstrate three key trends in their governance structures and investment policies:

Traditionally, public pension reserve funds have invested conservatively and been subject to political control with an emphasis on the pursuit of public purposes, often at the expense of returns. Funds have been used to invest in low-yielding government projects, for example housing loans or infrastructure in Japan and South Korea, or loaned to the government at below market rates. 

Alexander Boersch, Senior Pensions Analyst at AllianzGI, says, "Demographic developments require investment in higher yielding assets. Given the ageing population, the capital of reserve funds is an important factor in smoothing contributions and the more efficient the risk-return profile, the less the burden on the public pension system. This implies the need for diversification of assets between asset classes and internationally."

While the study reveals a growing awareness of the need to maximise returns, investment by reserve funds in financial markets is a complex matter. The size of these funds means that they are big enough to move markets. That they are government or government-affiliated organisations also complicates direct foreign investments. If the reserve fund were to invest directly in foreign firms, a political backlash in the respective countries would be likely, as has recently occurred with the investments of sovereign wealth funds from emerging economies in Western companies.

A way to diversify and circumvent the investment issues mentioned above is to oblige the pension reserve fund to adhere to the goal of maximising returns by outlawing other goals, outsourcing asset management or limiting government interference. A de-politicisation of the investment process eases equity investment and asset allocation. These measures also imply an increased professionalism of asset management which helps maximise returns.

The governance and investment policies of Asian pension reserve funds are in transition. Their new strategy can be best described as putting returns first and is being supported by increased outsourcing and diversification of assets, a retreat from public or government financing and a growing professionalism of board governance. These developments benefit future pensioners whose pension payouts are partly dependent on the performance of the assets managed by the reserve funds.  In this way, professional management of these funds is critical for the future sustainability of public pensions.

The patterns observed in this report have ramifications for global financial markets as the rising share of international and equity investments in the portfolios of these reserve funds means that their importance in the global financial markets will increase substantially. As with sovereign wealth funds, the sheer size and societal impact of these reserve funds will inevitably bring issues like internal governance, political influence and transparency into the public spotlight. This will make clear goals, sophisticated investment strategies and solid governance structures all the more important.

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