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Expanding Long-Term Capital Market Share
Introduction
On September 24, 2024, at a press conference held by the State Council Information Office, Pan Gongsheng, the Governor of the People's Bank of China, announced two significant structural monetary policy tools: First, the creation of a swap facility for securities, funds, and insurance companies to support eligible institutions in obtaining liquidity from the central bank through asset collateralization; second, the establishment of a special re-lending facility for stock buybacks and share increases, guiding banks to provide low-cost loans to listed companies and major shareholders to support stock buybacks and share increases. In addition to these short-term measures, relevant departments such as the China Securities Regulatory Commission have formulated the "Guiding Opinions on Promoting Medium and Long-term Capital into the Market," which requires a more comprehensive strategy to encourage medium and long-term capital to enter the market. The policy level's attitude towards encouraging capital to enter the market is very positive and clear, but the willingness of medium and long-term capital to enter the market is often "not satisfactory."
Why is the proportion of long-term capital entering the market so low?
The proportion of equity investment in our country's pension funds and insurance funds is only 10% to 20%, which is far lower than the international level of about 50%, and also far from the policy-specified limits of 40% for social security funds and 45% for insurance funds. At the same time, in the asset allocation of our country's insurance funds and social security funds, investments such as bonds, deposits, and equity have relatively stable returns, while the allocation to equity classes such as stocks and funds is overly "conservative." This difference shows that our country's long-term capital has insufficient participation in the equity market, which is to some extent not conducive to financial market risk prevention, global factor attraction, and dealing with the accelerated aging of the population and residents' pension security.
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Taking the National Social Security Fund (Social Security Fund) as an example, from 2018 to 2020, after A-shares completed a three-step process to include a 20% weight in the MSCI Emerging Markets Index, the passive channel for international medium and long-term capital to enter A-shares was opened. The Ministry of Finance announced and implemented the "Interim Measures for the Investment Management of the National Social Security Fund" in December 2021, further clarifying the investment limit of the Social Security Fund in stocks and funds to 40%, further giving the Social Security Fund greater investment flexibility. Although the proportion of equity allocation of the Social Security Fund has not been disclosed, it can be seen from its annual financial statements that its equity allocation ratio does not seem to have significantly increased after 2021.
From 2020 to 2022, although the total scale of the Social Security Fund decreased from 2.92 trillion to 2.88 trillion, the overall decline (1.34% or 0.04 trillion yuan) is not significant compared to the overall scale (nearly 3 trillion yuan). It is observed that the proportion of "trading financial assets" in the Social Security Fund's financial statements increased from 48.32% in 2020 to 55.10% in 2021, and then decreased to 51.81% in 2022. This indicates that the Social Security Fund significantly increased its participation in the short-term favorable market, but quickly reduced it in a weak market, but the overall proportion of trading financial assets did not increase with the increase in the equity investment limit.
At the same time, insurance funds, as another important source of medium and long-term capital, their market entry situation is also worth paying attention to. According to data from the Financial Regulatory General Bureau, in 2021, the balance of insurance funds used reached 23.23 trillion yuan, of which the proportion invested in stocks and funds was 12.70%, and the overall distribution of the comprehensive yield rate of the insurance industry was concentrated within 5.5%. In 2022, the balance of insurance funds used increased to 25.05 trillion yuan, with the proportion invested in stocks and funds being 12.71%, and the overall distribution of the comprehensive yield rate of the insurance industry was concentrated within 3%. In 2023, the balance of insurance funds used reached 27.67 trillion yuan, of which the proportion invested in stocks and funds was 12.02%, and the comprehensive yield rate was 4.02%.
These data indicate that both social security funds and insurance funds show a very cautious attitude towards entering the market in the face of market fluctuations, and their equity investment ratio has remained at a low level and has a downward trend. Since the social security fund is the livelihood money of the people, and insurance funds or corporate annuities have the pressure of rigid expenditures every year, they will inevitably choose low-risk high dividend or fixed income investment varieties.
This phenomenon also shows that our country's long-term capital has insufficient participation in the equity market. Compared with the equity investment ratio of the Japanese Government Pension Investment Fund (GPIF) close to 50% and the Canada Pension Plan Investment Board (CPPIB) over 60%, our country's long-term capital's willingness to enter the market is more cautious and conservative. This trend is to some extent not conducive to playing the role of a market stabilizer for long-term capital, and it is also unable to fully utilize the function of the capital market to serve the real economy and help the economy transform and upgrade. Looking further into the future, with the acceleration of the aging population process and the increasing pressure of residents' pension security, if medium and long-term capital cannot actively participate in the capital market and obtain long-term investment returns, it may not be able to cope with future challenges.
Market liquidity tools may be a "double-edged sword."China's capital market still has some deep-seated structural contradictions and problems, which to some extent restrict the enthusiasm of medium and long-term funds entering the market. The main manifestations are: First, the stock market has large fluctuations, the quality of listed companies is uneven, and the concept of value investment has not yet taken root in people's hearts, leading to a lack of confidence in the equity market for long-term funds; Second, the construction of the bond market system is relatively lagging, credit risk events occur from time to time, suppressing the allocation needs of institutions such as insurance and pension funds; Third, in the fields of derivatives and alternative investments, China still has a significant gap compared with mature markets, and it is difficult to meet the risk management and asset allocation needs of long-term funds.
Faced with the insufficient willingness of China's medium and long-term funds to enter the market, the China Securities Regulatory Commission and other relevant departments have formulated the "Guiding Opinions on Promoting the Entry of Medium and Long-term Funds into the Market", focusing on three major measures: vigorously developing equity public funds, improving the institutional environment for "long money and long investment", and continuously improving the capital market ecosystem. Specifically,
First, vigorously develop equity public funds. The focus is to urge fund companies to further correct their business philosophy, adhere to the orientation of investor returns, focus on improving investment research and service capabilities, create more products that meet the needs of the people, and strive to create long-term returns for investors. The China Securities Regulatory Commission will further optimize the registration of equity fund products, vigorously promote the innovation of broad-based ETF and other index products, and launch more ETF fund products including small and medium-sized plate ETF funds such as the ChiNext and STAR Market in a timely manner, better serving investors and serving the development of national strategy and new quality production capacity.
Second, improve the institutional environment for "long money and long investment". The focus is to improve the regulatory tolerance for the equity investment of medium and long-term funds, fully implement a long-term assessment cycle of more than 3 years. Break through the institutional barriers affecting long-term investment of insurance funds, promote insurance institutions to become firm value investors, and provide stable long-term investment for the capital market. At the same time, guide the multi-level, multi-pillar pension security system to interact positively with the capital market, improve the investment policy system of the National Social Security Fund and basic pension insurance funds, and encourage enterprise annuity funds to explore different types of differentiated investments based on the different ages and risk preferences of the holders.
Third, continue to improve the capital market ecosystem. The focus is to take multiple measures to improve the quality and investment value of listed companies, improve the supporting institutional arrangements for institutional investors to participate in the governance of listed companies, and at the same time severely crack down on various illegal and irregular behaviors, creating a good market ecosystem where medium and long-term funds "are willing to come, stay, and develop well".
These measures complement the swap convenience policies, jointly creating favorable conditions for incremental funds to enter the market. Essentially, whether it is creating swap conveniences for securities, funds, and insurance companies, or creating special re-lending for stock buybacks and increases, these two important structural monetary policy tools aim to provide more liquidity support for the capital market.
On the one hand, they can provide "market-saving" tools for institutions when the market experiences a sharp decline and liquidity risk, improving the efficiency of crisis response, preventing systemic risks, maintaining market stability, and boosting investor confidence. As Governor Pan Gongsheng said, the purpose of establishing these two tools is to form a multi-level, wide-coverage financial market stability tool system and play a counter-cyclical adjustment role.
Taking the swap convenience tool as an example, the biggest advantage of this tool is to enhance the market's emergency response capability. When a sharp decline and liquidity risk occur, this policy can provide institutions with greater market-saving efforts, greatly improving the efficiency of crisis response. This not only helps to prevent systemic risks and liquidity risks, maintain the medium-term stability of the capital market, but also conveys a positive signal to the market and boosts investor confidence.
However, on the other hand, we must also see that no market-saving tool is omnipotent and still has a "double-edged sword" effect. The most significant is the potential to exacerbate the market's "helping rise and helping fall" effect. When the market sentiment is excited, institutions may take the opportunity to significantly increase leverage, leading to excessive market gains; when the market falls, institutions may be unwilling to use this policy to add positions due to pessimistic sentiment, failing to achieve the purpose of stabilizing the market. This frequent significant fluctuation may not be conducive to the long-term stable growth of the market and is not conducive to forming an ideal "slow bull" market. In addition, if used improperly, it may also lead to the transfer of financial risks to the banking system, increasing the overall risk of the financial system.
Therefore, while these short-term policies play a "fire extinguisher" role, they also need strict supporting mechanisms to prevent the spillover of risks. From a deeper level, the frequent introduction of market-saving policies reflects that China's capital market ecosystem is not yet healthy enough, and the internal stability mechanism is not yet perfect. Faced with complex and changeable external environments and arduous reform and development tasks, relying solely on short-term policies for "blood transfusion" is difficult to fundamentally solve the market's structural contradictions. We must improve the multi-level market system, especially to vigorously develop a professional and market-oriented institutional investor team. Among them, cultivating and strengthening the strength of medium and long-term funds such as pension funds and insurance funds is a crucial link.There is significant room for long-term capital to enter the stock market.
In fact, cultivating and strengthening the forces of medium to long-term capital such as pension funds and insurance funds often plays a pivotal role in mature markets. Taking pension funds as an example, the asset scale managed by the U.S. public pension funds is approximately $4.5 trillion; the scale of private pensions also reaches $35.4 trillion, equivalent to 1.3 times the U.S. GDP. In Japan and Canada, the proportion of pension assets to GDP is also as high as 63% and 92%, respectively. These massive, long-duration matching long-term funds are not only important participants in the multi-level markets such as stocks and bonds but also play a unique role as "ballast stones" and "stabilizers" with their prudent investment philosophy and professional investment research capabilities.
In addition, overseas long-term capital also has many aspects worth learning from in terms of the use of investment tools, risk management, and asset allocation. Taking U.S. pension funds as an example, according to data from Pensions & Investments, as of the end of 2022, more than half of the 200 largest U.S. pension funds used derivatives such as stock index futures, interest rate swaps, and credit default swaps to hedge against inflation, interest rate, and credit risks. At the same time, these funds' average allocation to alternative fields such as private equity, real estate, and infrastructure has also reached 26%, an increase of nearly 10 percentage points over the past decade.
Looking at Europe, pension funds in countries such as the Netherlands, Switzerland, and the United Kingdom have brought diversified and global asset allocation to the extreme. Taking the Netherlands as an example, with its well-developed financial infrastructure and open capital markets, the proportion of foreign investment by Dutch pension funds is as high as over 80%, with equity assets accounting for more than 50%, and fixed income also has nearly 40% allocated overseas, fully diversifying geopolitical and exchange rate risks and capturing investment opportunities from a global perspective.
The successful practices of long-term capital in these developed markets rely not only on sound top-level design and institutional arrangements but also on open and efficient multi-level capital markets, and even more on the concerted efforts of all market participants to jointly create an ecosystem where "each beauty appreciates its own and others' beauty". Looking at our country, to fully unleash the vitality of long-term capital, more effort is still needed in optimizing institutional supply, innovating product tools, strengthening risk control capabilities, and improving market ecology.
For example, international pension institutions such as the Government Pension Investment Fund (GPIF) of Japan and the Canada Pension Plan Investment Board (CPPIB) have adopted more active investment strategies and have achieved significant results in asset allocation diversification and risk management. For instance, as of 2022, the proportion of equity investments by GPIF is close to 50%, while the proportion of equity investments by CPPIB (including public markets and private equity) is even over 60%.
In addition to the "three major measures" introduced by the China Securities Regulatory Commission in the "Guiding Opinions on Promoting the Entry of Medium and Long-term Capital into the Market", more strong reform measures can be taken in the future to further expand the investment channels of long-term capital, enrich risk management tools, and improve the assessment and incentive mechanisms. Drawing on these international experiences, to unleash the vitality of China's long-term capital and promote the high-quality development of the capital market, the first step can be considered from expanding the scope of "tools" used by long-term capital.
Recommendation One:
Expand the scope of investment tools for long-term capital
In response to the current investment preference of China's long-term capital, which "focuses on bonds and neglects equity", it is recommended to further expand the scope of investment tools for pension funds and optimize risk hedging strategies. At present, the investment tools for long-term capital such as pension funds and insurance funds in China are relatively limited, which to some extent restricts their risk management capabilities and investment flexibility. In contrast, leading international pension institutions have more experience in this area that can be learned from. Japan's GPIF allows the use of derivatives such as stock index futures and Treasury futures for hedging, which enables GPIF to better manage investment portfolio risks. According to GPIF's 2022 report, by using these tools, it has effectively controlled the overall risk of the investment portfolio, maintaining relatively stable performance even in times of significant market fluctuations.At the same time, the Canada Pension Plan Investment Board (CPPIB) more broadly employs a variety of derivatives, including swaps and forwards, for risk management. The CPPIB's financial report for the fiscal year 2024 indicates that by flexibly utilizing these financial instruments, CPPIB not only effectively manages investment risks but also generates additional investment returns. For instance, CPPIB leveraged derivative strategies to achieve a 10.8% return on fixed-income investments, significantly higher than the returns of traditional fixed-income investments.
Therefore, expanding the range of investment tools for pension funds can amplify the yield on bond market investments during equity market downturns and also serve to enrich their risk hedging tools. Further liberalization of the use of more financial derivatives, such as options and futures, by long-term capital in China is advisable. Specifically, it could be considered to relax restrictions on the use of stock index futures and Treasury futures, and allow long-term capital to invest in structured products linked to stock indices. These products can provide downside protection while allowing investors to share in some of the upside gains, making them highly suitable for the risk preferences of long-term capital. This would also permit long-term capital to use these tools for risk management within a certain proportion, thereby enhancing their risk hedging capabilities.
These measures will help to improve the risk management capabilities of long-term capital, increase investment flexibility, and potentially raise overall returns. Taking insurance funds as an example, if they could use derivatives more flexibly for risk management, insurance companies might be more confident in increasing their equity investment ratios, thereby有望 raising long-term investment returns.
Currently, most of the funds for social security, corporate annuities, etc., are entrusted to domestic public mutual funds, insurance asset management, and other asset management institutions for management. Their investment styles tend to be similar, and they have not achieved significant excess returns over the years, which warrants reflection. Why not entrust them to well-known domestic or foreign private investment institutions for asset management? After all, some of these asset management institutions have extensive experience in managing pension funds, strong multi-asset allocation capabilities, and good use of hedging tools, achieving good performance and reputation both domestically and internationally.
Recommendation Two:
Further broaden the investment channels for long-term capital
The restrictions on overseas investments for long-term capital can be further relaxed, adopting a "direct + entrusted" investment model, and encouraging medium to long-term capital to engage in deep cooperation with top global asset management companies. Compared to the overseas investment ratio of about 50% for Japan's Government Pension Investment Fund (GPIF) (according to GPIF's 2022 report, its overseas stock investments account for 25.06% of total assets, and overseas bonds account for 25.23%), and the overseas investment ratio exceeding 80% for Canada's CPPIB, the current proportion of overseas market allocation for China's social security funds, insurance funds, and the second pillar of pension funds, corporate annuities, is extremely low. For example, the upper limit for overseas investments for social security funds is 20%, but the actual allocation is usually around 8-10%; although insurance funds can invest up to 15% of total assets in foreign assets, most insurance companies' actual overseas investment ratio is less than 5%; corporate annuities' overseas investments through the Qualified Domestic Institutional Investor (QDII) channel are even more restricted to within 10% of net assets, with actual allocations often lower.
It is more noteworthy that the allocation channels for these medium to long-term funds in China are relatively "single" and mainly rely on the QDII channel. International leading pension institutions such as Japan's GPIF and Canada's CPPIB have adopted a more proactive global investment model for overseas investments. These two pension institutions combine direct investment with entrusted investment for overseas investments. For example, they not only set up offices in major financial centers, established professional internal investment teams, gradually increasing the proportion of direct investment management of overseas markets internally, but also strengthen deep cooperation with top global asset management companies.
Therefore, for the overseas investments of China's medium to long-term capital, it is necessary to gradually increase the proportion of overseas investments, especially the proportion of direct overseas investments, while improving the risk management system for cross-border investments. In addition, cooperation with top global asset management companies should be strengthened. By establishing a "direct + entrusted" strategic partnership, leveraging entrusted investments to utilize these institutions' advantages in specific markets or asset categories, and learning advanced investment philosophies and risk management techniques.
Recommendation Three:Establishing a "Stabilization Fund" for Long-Term Capital Security
The national level should promptly establish a stabilization fund for the A-share market, which would be the most powerful support for the growth and development of patient capital and for encouraging long-term capital to enter the market. Currently, there is a circulation issue in China's capital market, where the inactivity of the secondary market leads to a sluggish primary market, and the decline in risk preference causes a large amount of capital to flow into the bond market. This is also the main reason why long-term funds are hesitant to increase their equity asset allocation ratio. Therefore, establishing a stabilization fund at the national level would be beneficial for expanding the scale of medium and long-term capital entering the market and significantly boosting the confidence in long-term investment in the market.
Furthermore, compared to swap convenience policies, a "stabilization fund" designed for long-term capital may be more conducive to the long-term stability of the market, which is the most powerful support for the growth and development of patient capital and for encouraging long-term capital to enter the market. For instance, the Ministry of Finance could take the lead in advancing a certain amount of "stabilization fund" to provide an insurance mechanism for institutions investing long-term in A-shares (such as insurance companies, social security funds).
In the future, it should be stipulated that social security, insurance companies, and corporate and occupational pension funds should annually withdraw a certain percentage from their investment returns as "stabilization fund" contributions, increasing the future scale of the "stabilization fund." This mechanism requires that only institutions meeting strict conditions can enjoy this policy, such as requiring long-term holding, dividends or reductions only after several years, etc. If there is a loss after long-term (e.g., 5 years) investment, this stabilization fund tool will provide a certain degree of compensation.
The potential advantage of this proposal is that it can effectively lock in the "market floor." By providing a certain guarantee for long-term investment, it enhances the confidence of institutions to invest against the trend, which is conducive to attracting more long-term capital into the market, improving market structure, and reducing short-term speculative behavior. Even if the fund may not actually need to be used, its existence alone can greatly boost market confidence. Since only long-term capital that meets strict conditions can enjoy this policy, it can also effectively prevent the encouragement of short-term speculative behavior.
Overall, by implementing these measures, we can expect to enhance the investment capacity of China's long-term capital, compensating for the disadvantage of inexperience in the short term. In the long run, this will not only help to improve investment returns and diversify risks but also promote the internationalization of China's capital market, enhancing China's influence in the global financial system. However, during the implementation process, close cooperation between regulatory agencies, investment institutions, and policymakers is needed to steadily advance under the premise of ensuring capital security. These measures will provide stronger financial support for China's pension system, effectively addressing the challenges brought by population aging, and also lay a solid foundation for China's long-term capital to participate in the global financial market.
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