How can global investors benefit from demographic change?
Demographic change is reshaping the global population – especially in developed countries – as birth rates fall and populations age. This is bringing shifts in the composition of the workforce, impacting economic activity and investment returns. Investors should recognise that demographics can be a friction on earnings growth, but also provide some exciting opportunities.
“Demographics is Destiny”
Auguste Comte, French philosopher (1798 – 1857)
Our four-part series investigates the key structural trends identified by Axiom Investors as the key drivers of long-term equity returns. Axiom refers to them as the 4D’s:
We previously published analysis of the economic effects and investment implications of deglobalisation and disruptive innovation. In this article, we investigate what the ongoing shifts in the global age profile mean for long-term economic growth and investment returns.
What are demographics?
The word ‘Demographics’ derives from the Ancient Greek words ‘demos’ which means people and ‘graphics’ meaning measurement. It analyses how populations change over time.
Demographics are becoming increasingly important as the age structure of global and national populations undergo profound structural change.
The size, growth rate and age distribution of any population depends on three factors:
- Birth rate – is falling as women achieve higher levels of education and pursue careers. Household formation is further delayed by high housing costs and university debt. Birth rates have fallen to 1.6 children per woman in Australia, 1.2 in China and just 0.9 in South Korea, all well below the 2.1 replacement rate.
- Death rate – has fallen due to improved pensions, welfare, health care, treatment of age-related conditions, hygiene and health awareness, e.g. smoking.
- Migration – of younger workers from poorer countries with limited life chances to developed economies with labour shortages reduces the latter’s age profile.
These factors are currently driving demographic change across developed economies.
Why does this matter to economic activity?
Economic growth is determined by the size of an economy’s labour force and its rate of productivity growth. Both fall as populations age, impacting trend growth rates and living standards.
When populations age, public spending shifts from education, training and infrastructure, which boost productivity growth, to healthcare and pensions, which do not.
This shift in spending coincides with increasing dependency ratios, which bring rising tax burdens that disproportionately impact younger workers’ living standards.
Higher taxes impact discretionary pension saving, delaying retirement, ensuring an older workforce. This is sometimes associated with lower rates of productivity growth.
An ageing population also brings a higher long-term neutral rate of interest (r*), through two distinct drivers. Firstly, when workers retire, they switch from accumulating capital to spending, reducing the supply of savings in the economy, which puts upward pressure on interest rates. Secondly, rising numbers of seniors increase demands on pension and public health systems, pushing up deficits and debt levels, which again tend to raise interest rates over the long-term.
This implies longer-term bond yields and business financing costs will be higher over the course of the economic cycle. Higher interest rates reduce investment and thus productivity growth, impacting corporate earnings and market valuations.
What are the investment implications?
Over the long-term, demographic change will cause higher interest rates and lower trend rates of economic growth. Yet, it will also bring significant stock and industry-specific impacts.
Spending patterns shift as retirees – many with significant savings – grow in number, increasing demand for healthcare and leisure items such as travel. Companies able to market effectively to these cohorts are well placed to grow earnings.
Labour shortages in developed markets might be addressed either through immigration (but this is tricky politically) or outsourcing overseas (which increases supply chain risk). Therefore, expect increasing demand for automation in manufacturing, and where applicable, in services. Companies able to apply proprietary technology to automate workplaces and optimise energy efficiency have the opportunity to grow earnings sustainably as demographics change. Labour shortages will also accelerate the adoption of generative AI innovation, expanding the potential market size of businesses aligned to structural growth in AI.
Equity investors should be especially curious about company balance sheets. While interest rates may remain ‘higher for longer’ in the current cycle, a higher neutral rate of interest implies this could be more permanent. Companies which grow earnings and deliver positive free cash flow will be better able to refinance debt and finance new investments in any credit environment.
Axiom Investors, who manage the Pengana Axiom International Funds analyse debt as one of four distinct structural themes. Their data driven process helps identify companies that can grow earnings sustainably against the background of these trends. The Fund has held positions in Atlas Copco and ST Microelectronics which help industrial companies facing labour shortages to automate their processes. It has also invested in health insurance provider Elevance Health and leading medical device manufacturer Danaher.
Demographic change is a long-term trend, so global equity investors should consider its impacts carefully when constructing investment portfolios.
Tim Richardson CFA, Investment Specialist
