Summer 2023

‘Let’s focus more on the certainties’

Taylor Pearce, senior economist at OMFIF, spoke with Torbjorn Hamnmark, head of strategic asset allocation at AP3, about the impact of demographic trends on growth, productivity and the energy transition.

Taylor Pearce: What are the implications of global demographic shifts for your long-term investment strategy? Does your approach differ by region?

Torbjorn Hamnmark: Demographic shifts are profound and relatively quick – much quicker and much bigger than we are used to seeing in previous decades. The changes tend to point in a similar direction globally. Primarily that is a lower population growth rate across developed economies and less developed economies. Although the starting point is completely different in many African countries, there is this shift in Africa as well. The baseline is lower underlying economic growth.

Part of economic growth is driven by the growth in population so, for some economies, this will be very profound. This includes countries in Asia like Japan, South Korea and China (but maybe more so in the countryside) and countries in Europe like Spain and Italy. The main exception when you look at the global stage is really North America and that might be one of the reasons to be relatively positive on the US as an economy to be invested in.

AP3 is not a big emerging market investor. But we are extremely dependent on underlying growth rates on a global scale. We have a home bias to Sweden, so Swedish demographics are very important. The country looks relatively stable, at least for now. That’s driven by a large degree of immigration over the past decades, which has kept underlying demographic growth rates fairly stable. So if we look at demographic growth rates, Sweden, the US and the UK are relatively okay, but Europe and Asia look a lot weaker.

The most important observation is underlying economic growth. But also, what will happen to tax revenues? How will these countries finance their social welfare? Those issues will be super important.

TP: Are there specific sectors or asset classes that will be particularly affected or present new opportunities from demographic changes?

TH: We have been, over the past few decades, focused on sectors that cater to the elderly, like health care, leisure sectors and consumer sectors more directed towards the older population. I suppose those sectors are still going to do relatively well.

On assets, you could try to understand what will happen to the real estate sector going forward. If you look at Japan, the country will definitely be at the forefront of this demographic shift. The real estate sector there has been dormant and lagging for decades. I think there will be some kind of oversupply in the sector as a result of this.

TP: Do you anticipate net withdrawals because of ageing populations? How are you looking to adapt your funding model and investment strategy to address this?

TH: For the Swedish AP Fonden 1, 2, 3 and 4, we do not have a specific liability side. We are simply a buffer fund for the overall Swedish state pension system. Of course, there is a discussion of how higher longevity or increased living ages will impact the system. But this doesn’t directly lead to a departure from net flows from the system. What would lead to this would be a rapidly shrinking labour force, but we do not really expect that in Sweden’s case. We do expect slower growth going forward, but still positive growth for years to come.

We are growing older, but that shift is so slow. If you look over the next decades, your expected increase in life length is counted by weeks and months. It’s nothing dramatic. It looks like life expectancy is stabilising, because we’ve already reached a level of good nutrition. Many developed countries have reached a new plateau in terms of life expectancy. The much more dramatic shift is in terms of people having fewer children and therefore shrinking the labour force.

TP: How does your institution approach incorporating demographic considerations into your investment decision-making process?

TH: As a strategist, my job is to point out a list of factors which are relevant for investment operations. For once, it’s not speculation when it comes to demographics. I think that’s an interesting observation in itself. I sometimes use the phrase, ‘Let’s focus more on the certainties rather than uncertainties’. And I think not only being a public pension fund but also a long-term investor, you really need to understand how the different economies are going to fund those social welfare systems. I’m sure this will have to hit tax rates, for example, in different economies, which might influence our investee companies as well if tax rates for companies start to drift higher.

TP: In the context of long-term economic growth, are there any other significant risks you consider? How do you mitigate these risks in your investment strategies?

TH: In addition to demographic change, the most profound risk is the energy transition. Regarding demographics, to some extent, this is good news. The strain on overall resources will decrease because we will soon plateau in the number of people living on the planet. That’s a positive sort of development around demographics.

The whole energy transition will take a lot of resources and will be very costly. Initially, funding the energy transition is going to be a challenge. The public system needs to be funded by taxes, and we also need private investment. We will have fewer savers going forward based on demographic trends. Demographics and energy transition both have to do with growth rates. Making something very costly is easier when you have strong underlying growth. I see a challenge going forward if we’re having lower underlying economic growth at the same time we are financing a very resource- and capital-intense energy transition

As a strong asset owner with a long investment horizon, we do not tend to divest from companies and sectors; we tend to stay long-term owners, encouraging companies to do the right thing, given our long-term perspective.

Finally, my other line of thought is artificial intelligence and automation versus demographics. A few years ago, we were talking about ‘robots’ taking away jobs. Lately we have been focusing on the shortage of labour. What will the balance be going forward with AI? I do not think we know. For sure, a lot of workers need to be replaced as they retire: in Germany alone we are talking about something like 1m people per year. Can the AI productivity increase keep up with this?

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