Private Household Financial Assets

Private household financial assets: the golden days of the past are a long way off

International Pension Papers

No. 1|2009

Allianz Global Investors International Pension Papers No. 1|2009

2

ContentPrivate household financial assets: the golden days of the past are a long way off – Introduction. . . . . . . . . . . . . . . . . . . . . 3

Development of financial assets – an international comparison . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4

Outlook. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6

Basic scenario . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6

“Additional savings” scenario . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8

Pessimistic scenario . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9

Positive scenario . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .9

Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11

Imprint . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11


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Private households around the world suffered savage blows to their savings in 2008, the likes of which have not been seen for many decades. In Japan, Australia, North America and Europe, households jointly lost a total of more than over EUR1 8.8 trillion in one year2. All over the world, equity markets closed the 2008 financial year with significant two-digit losses. The slump is particularly severe as real estate markets also crashed and affected investments not previously seen as having significant correlation. In contrast to the past, a widely diversified portfolio offered minimal protection. In this respect, the current developments are unusual and outcomes cannot be predicted with any certainty. While there are weak signs of a recovery in the real economy, no one knows if this will be strong enough to pull the world out of the crisis. How quickly and sustainably private households can recover their financial losses will depend largely on the extent and length of the recession, especially since unemployment and a fall in disposable income will also limit savings potential.

Private household financial assets: the golden days of the past are a long way off

1 Converted at the 2008

exchange rate

2 The 2008 year-end

figures were available for

most European countries;

figures for the Netherlands,

Switzerland and Denmark

were missing at the time

this report was written.

These figures are based

on estimates, which are

combined as “Western

Europe”. The data for

Eastern Europe is based

on estimates by UniCredit.

Introduction


4

A t the end of 2008, the gross financial assets of private households in the USA

totaled EUR 29.6 trillion compared with EUR 35.8 trillion in 2007 – a loss of 17.4%. This loss was considerably higher than in Western Europe where savings fell from EUR 25.5 tril-lion to EUR 23.5 trillion, a loss of “only” 8%. The smallest decline experienced by the countries under consideration was in Japan with 5.5% (EUR 9.5 trillion to EUR 9 trillion).

Even after the crash, US private house-holds had gross financial wealth in relation to the GDP of 289%, a figure higher than in Western European households3 (198%), but lower than Japan (293%). However, as Japanese GDP also fell in 2008, this does not necessarily indicate that Japan is standing strong during turbulent economic times. Rather weak eco-nomic growth and low interest rates over the last 15 years means Japan has seen no signif-icant leap in financial assets. The picture is different in the two other regions: on balance, private households in the USA and Western Europe doubled their financial wealth be-tween 1996 and 20074.

However, financial assets developed unsteadily in the 12 years to 2008. Financial

assets in the USA and Western Europe rose in three years (1996 to 1999) and this was thanks to a stock market boom and a strong affinity for equity investments, especially in the UK and USA. In the same period growth in Japan was modest, partly because of the crisis in neighboring countries.

Assets, particularly in the US, literally dis-appeared after the stock exchange crash that followed in the wake of the dotcom bubble. Private household financial assets decreased over three years and at the end of 2002 were 15% lower than in 1999. When the tide turned in 2003, this decline was recovered in less than a year. Savings patterns in Western Eu-rope were similar to the USA. However, the more conservative investment behavior in the euro zone meant losses was not as high as in the USA. Instead, between the critical years of 2000-2002 European financial assets stagnated.

While the positive stock market from 2003-2007 encouraged many Europeans to invest either directly or indirectly in equities again, others – for example, German private households – took advantage of the price rises to sell. In some cases, these were investments

Development of financial assets – an international comparison

* Allianz Global Investors’ estimates for some Western European countries 2008; Sources: Central Banks, Statistical Offices, Allianz Global Investors

Financial assets of private households – selected regions in comparison [1996 = 100]

3 Western European EU

members plus Norway

and Switzerland

4 Comparable data for

Western Europe is not

available; smaller coun-

tries in particular do not

yet have long-term histor-

ical data available due to

new financial accounting

regulations for private

households.

120

180

160

140

220

200

19971996 1998 1999 2000 2001 2002 2003 2004 2005 2006 20082007

80

100

USA

Japan

Western Europe *


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that have been bought towards the end of the boom in the late 1990s. Equity markets showed signs of turbulence in 2007, making Europeans even more risk averse. Money was transferred into safer investments. On the interest front, too, the difference between short- and long-term rates declined in 2007, encouraging savers to invest in term deposits and other forms of banks savings. The turbulence in 2008 exacerbated the situation further and reinforced the cautious behaviour of private investors. Consequently the trend away from bank deposits towards capital market prod-ucts that had been evident over a number of years has come to a temporary end. Nevertheless the portfolio structure in Eu-rope remains more conservative than in the USA, even if banking investments have seen a minor renaissance in the USA recently.

The savings business has become in- creasingly professional in recent years. For example, private portfolios now include more funds as well as insurance products and pension funds. Pension funds in particular have experienced steady growth on both sides

of the Atlantic. In the USA this is because more funded pension schemes exist. In Europe a number of countries have undergone reforms calling for stronger funding elements to the pension system. This is driven by long-term financing issues that threaten state pension systems. Professionalisation seems to have had a positive effect in Europe on the develop-ment of financial assets as insurance com-panies structured their portfolios more con-servatively in light of experiences during the crash at the turn of the century. For private households the performance of this product group was consequently more stable than in the USA. In addition, the fall in property prices also had an indirect effect on financial assets since the valuations of nonquoted compa-nies, in which private savers can invest, also includes real estate assets. In the USA the product group “unincorporated proprietors business” accounted for a sizeable 18% of the household portfolio. These differences help to explain why European losses in 2008 were not as severe as those in the USA.

1996 2000 2007 20081996 2000 2007 2008 1996 2000 2007 2008

Western Europe * USA Japan

Figure 13

% of

tota

l ass

ets

60

40

20

80

100

0

Bonds

Bank deposits

Shares/ mutual funds

Insurance/pension plans

Other

35.4

11.2

25.1

27.8

0.6

27.8

7.3

30.7

31.2

3

30

6.2

26.2

34.2

3.5

34.7

6.7

20.2

34.5

3.9

14.6

9.9

14.4

29.1

2.1

8

13.2

30.3

2.4

47.3

6.9

15

7.9

14.8

44.9

29.3

3.1

19.1

9.1

39.9

28.2

3.7

53.6

7.2

8.3

25.8

5

51

10.1

8.9

26.4

3.6

54.7

8.5

5.9

27

4

51.3

9.6

9.3

25.6

4.3

* Allianz Global Investors’ estimates for some Western European countries 2008; Sources: Central Banks, Statistical Offices, Allianz Global Investors

Structure of financial assets of private households in selected regions


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Box 1

Determinants for the build up of financial assets

The household sector’s financial assets are calculated in the financial flows statistics provided by Central Banks or National Statistical Offices. The aggregate financial account shows by whom, on what scale and in which form financial resources were made available in an economy. It comprises those transactions that occur in the financial sphere and records the amount of financial assets and liabilities on a given date. In this way it provides an overview of the underlying structure of the financial systems and of sectoral behavior (households, enterprises, government and others).

Holdings of financial assets are valued at market prices (or estimated market-based prices). In the case of unsecuritized claims and liabilities, this largely corresponds to the nominal values (for example, bank deposits), in the case of shares, for example, to the daily market prices. The amounts stated for insurances correspond to technical reserves.

Changes in market prices are an important determinant for changes of financial assets. Other components are the flow of funds. In this context it is important to remark that the amount of savings differs from the flow of funds. The savings ratio is usually calculated as the difference between income and consumption and often used as an indicator for savings behavior. But this might be misleading for cross-country comparisons because of calculation methods. Contributions to pension schemes are not part of the savings volume and are treated differently to investments in other financial assets, such as bank deposits. While the former is recorded as an expense for households in the national accounts (so, reducing saving, but increasing wealth), the latter is viewed as savings. This explains how countries with large funded pension systems often have low savings ratios, but high financial wealth (as a share of GDP). This explanation puts the low savings ratio of US and British households compared to the higher ones in Germany or France, for example, into perspective.

After more than one and a half years of financial crisis, depressed equities and

steady deterioration in the real economy, it is only now that markets are seen as re-turning to a measure of stability. For private households, the question is how long will it take them to rebuild significantly depleted nest eggs? This question is critical in coun-tries where funded pension schemes play a large role and equities account for a high share of financial assets. The losses experi-enced in these countries were proportion-ately high.

As past experience shows, it is difficult to forecast the development of financial assets as this depends on factors such as the per-formance of equity markets and changes in interest rates and income (see Box 2). In addition, preferences for particular forms of investments also depend on factors that are difficult to forecast, such as legal, regulatory or fiscal changes. This is particularly true in the current environment where investors and market players are unsure and considering their responses. The only sensible method to chart potential developments is by outlining different scenarios.

Outlook

Basic scenario

In this projection it is assumed that there will be a long-term change in the structure of financial portfolios of private households. Estimates are based on the performance

of potential growth paths in the economy. The basic scenario assumes that the current positive signals will lead to sustainable im-provements in the short term and that the


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*Allianz Global Investors estimates from 2009 onwards

Financial assets of private households – selected regions in comparison | Base Scenario [1996 = 100]

160

280

240

200

320

19981996 2000 2002 2004 2006 2008 2010* 2020*

80

120 USA

Japan

WesternEurope

variation of the different scenario results

economy will recover in the second half of 20095 as wide-ranging economic programs start to take effect. On balance, economic per-formance in 2009 will be negative, but this will not be fully reflected in disposable in-come. In addition, the low inflation rate will give households more financial scope than in mid-2008. Between July 2008 and the first quarter of 2009 the inflation rate fell from 3.3% to 1%, partly as a result of lower commodity prices. For example, in mid-2008 the oil price was still over USD 140 per barrel, almost three times as high as at the beginning of 2009.

This development, coupled with caution on the part of investors and the efforts of many private households to even out losses, especially where pensions are concerned, should lead to slightly higher investments. For the purposes of this scenario it is also assumed that at the end of 2009 the stock exchanges will have returned to the 2008 year-end level. In the first quarter of 2009 the major exchanges in Europe and Asia lost ap-proximatley 20% of their value. Although there has been a strong, fast recovery in the second quarter, uncertainty still prevails. It is also as-sumed that the situation will normalise from

the beginning of 2010 with an equity perform-ance of 7% p.a. forecast for the period.

Under this scenario the financial assets of private households in the USA will increase to EUR 45.5 trillion by the year 2020. This is 54% higher than at the end of 2008 and represents an average annual increase of 3.6%. On the basis of 2007 figures, only 1.9% would be achieved. This would be the lowest annual average growth measured over a decade since the 1950s6. The severity of the 2008 slump is reflected in the length of time required for as-sets to return to the 2007 level. On the basis of the assumptions in this scenario, which takes into account a turnaround in the economy and slightly calmer financial markets, it will take until 2014 for finances in the USA to recover.

In Western Europe the slump was not so dramatic and more has been saved on average over the years. In the basic scenario for these countries, the dent can be smoothed out in 2011. In Western Europe financial assets are expected to increase by 74% to a total of EUR 41.4 trillion in 2020 or 4.7% p.a. This means that assets in Western Europe will gain on those US households. In Japan it will

6 This analysis is based

on figures starting from

1952.

5 Forecasts are based

on estimates by Allianz

Economic Research &

Corporate Development.

Economic forecast

2009/2010, Working

Paper 124, March 2009.


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Source: Allianz Global Investors, International Pensions, July 2009

Time needed to surmount the 2008 wealth losses

20092008 2010 2011 2012 2013 2014 2015 2016 2017 202020192018

Western Europe

USA

JapanBase

Negative economy

Positive

Additional saving

Base

Negative economy

Positive

Additional saving

Base

Negative economy

Positive

Additional saving

be difficult to increase assets. Lower growth, lower interest rates, a high proportion of bank deposits and a weak life assurance business due to the rapidly ageing population could all mean that it will take well into the next decade before the 2007 level is reached again.

In this scenario Western Europe would seem to have the best chances of a quick recovery. This is mainly due to the fact that Continental Europeans have traditionally been regular savers. In addition the second

and third pillars of retirement pension schemes have been continuously developed with investors aiming for a balanced mix of safe investments and promising opportuni-ties. However, it is still very uncertain as to when private investors will regain their confi-dence in more complex forms of investment in the capital markets. The last crisis at the turn of the century may have shaken people’s faith in systematic, long-term accumulation of assets, but the big crash in 2008 could have destroyed this completely. 7 See Box 1 for the factors

influencing the develop-

ment of assets and the

resulting scenarios.

8 See Box 1 for the effects

of savings ratios and con-

tributions to retirement

pensions on the develop-

ment of financial assets.

The pressing problems in connection with pensions and the gaps in the pension funds may mean that private householders have to save more7. For this reason, in the “Addi-

tional savings” scenario, we assume house-holds will save more , which could either mean saving more of their income or mak-ing higher contributions to pension schemes8.

“Additional savings” scenario


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Positive scenario

The majority of assets are in fact accumulated in order to prepare for retirement, either as private savings or through company pension schemes. Due to the huge losses in the capital stock of pension funds, many companies will try to bridge the gap by increasing contribu-tions. This would be a possible reaction in the USA.

Higher regular contributions to pension schemes in particular could lead to a growth in financial assets in the USA of almost 5% p.a. (between 2008 and 2020). This scenario shows high growth potential because retire-ment products account for a high percent-age (about one third) of the financial assets of private households. The financial wealth of American households could reach EUR

52.6 trillion, which would almost match the growth in Europe. In this case the relative positions of the two regions would remain stable in comparison with 2008: Gross finan-cial assets in the USA would be about 25% higher than in Western Europe, where in this scenario they will be around EUR 42.4 trillion in 2020. The difference from the basic scenario will not be as marked in Western Europe because the saving level there is already high, so there is little room to increase it: Europe would again reach the 2007 level by 2010. In the USA the higher inflow to pension schemes and savings would reduce the regeneration period by about one year. This means the 2007 level could be reached by the year 2013. As in the basic scenario, no significant im-provement is expected for Japan.

Pessimistic scenario

In view of the current situation, with the global economy in the worst recession for 80 years and no sustained recovery in sight, a more pessimistic development cannot be ruled out, especially as the positive impulses from the current ambitious economic pro-grams are likely to lose strength in 2010/2011. The pessimistic scenario assumes a longer recession and a much slower recovery on equity markets. In particular, it is assumed that equity markets will decline by another 15% by the end of 2009, will stagnate on bal-ance in 2010 and only close with a slight plus in 2011.

Under such a pessimistic scenario, higher unemployment is to be expected as are lower pay rises or even pay cuts as, for example, the effects of reduced hours are felt. This means

Based on the recent years, it is possible to imagine that equity markets will recover their strength to such an extent that there will be

disposable income will be negatively affect-ed and savings potential noticeably reduced. In the USA employees reaching the end of their working lives may postpone retirement, which could have a certain counter effect, as pension fund capital would not be required immediately and could be stocked up. Based on these assumptions financial assets in the USA will only grow to EUR 42.6 trillion by the year 2020 (3.1% p.a.). It will be 2017 before the volume of assets has reached the level of 2007 again. In Europe, too, growth of finan-cial assets will be approximately 0.5% lower p.a. in comparison to the basic scenario. The relatively stable inflow of funds in Europe will have a stabilizing effect on the overall perform-ance of financial assets in this scenario, too. It will take until 2012 before the 2007 level has been reached again.

a marked swing from extreme negative trends to equally positive ones. For example, between 2003 and 2007 the recovery on equity markets


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Box 2

Scenarios for the development of financial assets

According to the determinants for financial assets there are different approaches for the scenario set up. In addition to a base scenario, other variants with “Additional saving” efforts are presented. In this case households of all countries increase their savings rate by 10% overall compared to the base scenario. For countries with strong funded pension systems an increase of contributions to pension schemes in 2009 and 2010 is assumed.

Different developments of financial markets were modeled in two versions. The positive scenario assumes a strong recovery comparable to the period 2003-2007. The negative scenario calculates a slower recovery of the economy than in the base scenario with a negative effect on income and financial markets. The result is a slower recovery of stock exchanges.

Results of another variant modeled on investment behavior and the resulting change of the investment mix in a given year will not be presented in this paper. There are only minor differences to the base scenario as the Europeans changed their investment behavior in 2008 to more conservative and cautious strategies.

Source: Allianz Global Investors, International Pensions, July 2009

Determinants for the build up of financial assets

Regulatory changes

Financial assets• Portfolio-mix

“Risk aversion”

Scenarios

Financial markets

“Positive” scenario(recovery as during 2003/2007)

“Negative” scenario

Income• Development• Split: consumption/savings;

contributions to pension plans

“Additional savings”Additional savings / higher contributions to pension plans

Flow

sValuations

was, at times, spectacular. If we assume in this positive scenario a similar recovery with a plus of 25% in 2009, a slight respite in 2010 (+10%) and another surge in 2011 (+20%), then the recovery period in the USA would be short-ened considerably. Assets could again reach the 2007 level by 2011. By 2020 the situation could be normalized and the wealth of private households could total EUR 53.2 trillion, which is comparable with the additional savings scenario.

The highest increase in assets given this scenario would be in Western Europe where the volume could almost double to EUR 46.1 trillion. This scenario would even see Japan experience sustainable recovery. This means that even in countries where people do not invest substantially in equities this scenario has the highest growth potential.


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The greatest growth potential would be realized in Western Europe and Japan if

the equity markets were to see a strong re-covery comparable with the years between 2003 and 2007. The possibility of such a de-velopment cannot be ruled out. After all, the markets have often experienced excessive reactions. On the other hand, the shockwaves that have rolled through the financial markets were the worst since the Great Depression of 1929. Investors’ confidence has been serious-ly impaired and, even if equity markets do see a strong recovery, private households may not participate directly. However, they might profit indirectly through involvement in pooled forms of investment.

Of course, the USA would also see high growth in the value of assets if this were the case, but the growth would be more sustain-able if there were also an additional influx of savings. If private households in the USA

saved more or paid higher contributions to pension schemes, the USA could see similar growth rates to those expected in Europe. In the major continental European countries in particular, people save noticeably more. Both regions could see growth of almost 80% by 2020 under the given conditions. But this scenario also has its downside since higher savings means less consumption, which has been the main growth engine in the USA for years. If Americans were to save just 1% of their disposable income of approximately USD 10.6 trillion then USD 106 billion less would be spent on consumables. This in turn could lead to a chain reaction that could have a negative effect on the world economic recovery, so the basic assumptions of this scenario may prove too optimistic. Never- theless, it seems unavoidable that, especially in countries where there are huge gaps in the pension funds, more will have to be saved and even then recovery will be a long time coming.

Summary

Imprint

Publisher: Allianz Global Investors AG, International Pensions, Seidlstr. 24-24a, 80335 Munich, Germany | [email protected]

http://www.allianzglobalinvestors.com | Author: Dr. Renate Finke, Senior Pensions Analyst, Allianz Global Investors AG, [email protected]

Layout: volk:art51 GmbH, Munich | Printing: Christian Döring GmbH, Munich | Closing Date: July 13, 2009

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Private Household Financial Assets

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