The lifecycle fund has developed rapidly over the past decade, and the speed of development even exceeded the overall market for pensions. In contrast, funds with similar target and risk has a much slower development. The problem we concern is whether there are some good factors for developing lifecycle funds in the Greater China market, and which kind of people is more suitable for those lifecycle funds.
Mature Pension System
After years of development, the United States has established a multi-level pension system. In addition to social security programs, the occupational and personal pension systems of the US have been consummated by government policies. In Hong Kong, the government has implemented the Mandatory Provident Fund (MPF) system since 2000. Both employers and employees have to contribute 5% of the salary of the employee to the fund. Since the final asset value is related to the income generated during the period, therefore, the operation of the asset management account determines the investment profit that the employee can obtain at last. Therefore, Hong Kong has introduced a Default Investment Strategy (DIS), which adopts a lifecycle management philosophy. As a result, lifecycle products have acquired a basis for development in Hong Kong.
On the contrary, endowment insurance is still the focus of the mainland pension system. Under this system, the government is the one responsible for the operation of the asset management account, investors do not need to account for the investment income. At the same time, according to the regulation “Measures for the Management of Enterprise Annuity Funds” from China, the allocation ratio of investment equities shall not exceed 30% of the net value of the investment assets under the enterprise annuity plan. Since the initial equity asset allocation ratio of the lifecycle fund is often higher than 70%, China lacks a basis for lifecycle products to develop currently.
Tax Incentives Promote Pension Development
Tax incentives is the most fundamental factor in the development of the occupational annuities. The United States implements three stages of tax measures on annuities, which is tax exemption for both contribution and investment, and taxation for payment respectively. This means that the US labor force can use part of its income as a pre-tax expenditure on pension savings tax, which reduces the current tax burden. The Hong Kong MPF system has similar arrangements too. The mandatory contribution part paid by the employee can be deducted in the taxable amount, and there is also no additional tax during the payment phase. However, the employee voluntary contributions or other means of savings will not be eligible for tax exemptions.
Meanwhile, in China, the “No. 103 , Ministry of Finance” provides policy support for corporate annuity tax deferral. This policy can be simply understood as there is no need to pay income tax during contribution, and the investment income does not require the personal part of the tax, and finally pay the income tax after one has received the annuity. This policy is very similar to the US policy. However, the Chinese system is not mature yet, residents may not be aware of investment using social security or pensions, therefore it is still necessary to conduct investor education for a period of time.
The product characteristics of lifecycle fund make it a suitable choice for being a default investment option. The lifecycle fund adopts a suitable investment strategy for different periods of life, and directly gives a one-stop solution for the difficulty investor facing upon selection. However, for the pension market in China and Hong Kong, the current pension system fails to effectively distinguish investors with difference risk tolerance. For low risk tolerance investors in Hong Kong, their primary pension goal is to hedge inflation to maintain purchase power, therefore, inflation hedge products are more suitable with the needs of this group of people. Only investors with medium to high risk tolerance are suitable for lifecycle products, which aims to increase the profits of the pensions.
In the next article of this series, we will focus on how lifecycle products optimize the allocation of human resources and financial asset, and how should those investors with medium to high risk tolerance benefit from dynamic asset allocation.