Close on the heels of death and taxes as inevitable ordeals of life is the spectre of demographic change. Although the economic consequences of a greying Canada are almost certain to be negative, there may well be opportunities for investors in these long-term trends.

The basic demographic story is similar in much of the developed world. The core working-age segment of the population is aging as a result of both dropping fertility rates and longer life expectancies. In many countries, including Canada, a large proportion of workers will soon be reaching retirement, dramatically shifting the ratio of workers to dependents over the next 50 years or so.

This could be bad news for the economy. A population comprising fewer workers and more retirees is likely to create a drag on economic growth, as: a greater proportion of the population becomes dependent on government transfers to support consumption; spending power declines as workers feel a demand on their finances to fund these transfers; and labour shortages arise.

Unless a health or environmental catastrophe occurs that drastically alters the composition of the population, the effects seem unavoidable. Some policy reforms could limit the damage, such as ramping up immigration, encouraging longer working lives, dramatically boosting worker productivity and facilitating personal saving for retirement. None, however, is likely to be enough to avert the full consequences of an aging population.

Nor are Canadians likely to follow the other path that could help ease the burden: having more babies. In fact, the impact of an aging population may create a feedback loop that exacerbates the problem by discouraging fertility.

In a paper published earlier this year, David Weil, a professor at Brown University in Providence, R.I., argues that population aging is primarily the result of past declines in fertility. In the short run, it provides an economic boost, he says, because declining fertility reduces the proportion of dependents in an economy, which boosts personal consumption. However, in the long run, you are left with the opposite problem: an aging population and more dependents.

In another recent paper, Weil and Heinrich Hock of Florida State University in Tallahassee, Fla., show that an aging population will probably further depress fertility. To combat the effects of slowing economic growth on their finances, workers will logically reduce the number of children they have. They can’t control the number of elderly people in the population that must be supported, but they can determine the number of children they must personally support.

“The dependency-minimizing response to increased longevity is to raise fertility,” Weil and Hock say. Yet, they warn, “In the face of the high taxes required to support transfers to a growing aged population, we demonstrate that the actual response of fertility will likely be exactly the opposite, leading to increased population aging.”

If demographic change is itself unavoidable, what are the probable implications for investors?

Some analysts suggest that one long-term trend will probably be weakness in stock markets and strength in fixed-income, as a large segment of the population moves from accumulating wealth to liquidating it to fund retirement.

Recent research, however, disputes that such uniform investment shifts are probable. James Poterba, professor at the Massachusetts Institute of Technology in Cambridge, Mass., has found only a weak link between demographics and asset prices, and no convincing evidence as to how much asset prices will be affected by an aging population.

Moreover, globalization may ameliorate many of the more extreme effects of demographic change. In a new report, UBS Wealth Management Research admits that an aging population will be a drag on economic growth, but argues that this phenomenon will have only a modest effect on financial markets and foresees a handful of themes for investors to play as trends evolve.

The UBS report not only provides several ways to play the inevitable demographic swings but also highlights the sort of evolution that will probably take place in capital markets. “Demographic shifts will probably be overshadowed by other fundamental trends, such as the geographical diversity of earnings, the integration of global capital markets and shifts in institutional pension plan holdings,” the report argues.

Indeed, as economies and markets are increasingly integrated, it makes less sense to talk about national corporate champions. Instead, truly global companies will emerge. “As corporations invest abroad and increase the geographical diversity of their sales and cost structures, earnings will increasingly decouple from home country economic growth rates,” the report notes.

@page_break@Moreover, interest rates will also increasingly become a global phenomenon. Arguably, the trend is already in place: developed countries, particularly the U.S., maintain very low savings rates yet enjoy relatively low interest rates, as higher saving, developing nations take up the slack.

The one demographic-driven financial market trend that UBS entertains is the idea that some equity markets may suffer as pension plans and individual investors move out of stocks in favour of bonds and other fixed-income vehicles as they draw down their savings in retirement.

UBS indicates that pension plans will be the prime drivers of the trend rather than individual investors. Therefore, UBS expects the effects will be most significant in countries with well-developed pension systems, such as the U.S. and Britain. Conversely, countries such as Germany, France and Italy, which rely on pay-as-you-go public pensions, may see greater demand for financial assets in their markets as they try to meet obligations.

The UBS report also spells out a number of investment themes that could arise in response to aging populations in the decades ahead. It notes that the key economic consequence of aging populations will be stagnant or contracting labour forces. Improved productivity may alleviate some of the economic strain, but is unlikely to nullify it entirely.

From an investment standpoint, UBS suggests that in the long run the labour-force effects should be negative for commercial real estate and office REITs, but positive for technology firms and IT outsourcing firms, as companies use more technology when faced with labour shortages. UBS also foresees a positive impact on railways, including both CN and CP, as rail transport takes up the slack arising from a shortage of truck drivers.

There are also a number of country themes running through the UBS analysis of the demographic trends. One is that the U.S. is better positioned than either Europe or Japan, which should generally bode well for U.S. stocks. However, within the U.S., fiscal pressures caused by an aging population may necessitate spending shifts that will be negative for defence contractors, luxury-goods manufacturers and certain health-care companies. Particularly at risk are health-care firms with fat margins, as they may face downward pressure on margins from financially strapped government health-care systems. Still, demand for drugs should be strong, benefiting generic-drug makers and drugstores.

The aging of the European population bodes well for Turkey, UBS says. It notes that Europe’s labour force growth will turn negative by about 2010, yet Turkey’s will grow at least 1% annually until 2020 or so. This may mean opportunities for Turkish workers in Europe and increased remittances back home, boosting the Turkish economy.

With growth slowing in the developed world, the report argues, robust growth in the developing world, notably in China and India, will become more important to companies. Those that are well positioned in those countries should benefit from the opportunity to build their infrastructure. Such expansion plays to the strengths of diversified capital goods makers, telecoms, diversified miners, global financial services firms, aerospace and consumer goods firms with strong market positions in these countries.

The developing world’s need for resources should boost energy demand, despite declining demand from the developed world. UBS says global energy demand will rise 2% annually in 2006-07, then slow to 1%-1.25% a year through 2010.

UBS notes China’s population is aging, too, and its labour force growth will turn negative by about 2015. This may benefit other countries with younger populations. India, for example, is expected to enjoy labour force growth of 1%-2% until around 2025, along with Malaysia, Vietnam and Singapore.

Although the basic trend may be negative, there are ways for investors to play the trend to their advantage. IE