US pension funds are massively home-biased, but direct allocations to emerging market equities are slowly rising. Nick Fitzpatrick reports from New York.
If the US economic recovery, which is reflected in a turnaround in the housing market, is sustained then US pension plans will be glad their equity allocations favour domestic markets.
But the home bias has also left many investors and pension fund members largely, perhaps wholly, out of the long-term emerging market growth story.
US pension plans had the greatest home bias in equities compared to their global peers, standing at about 75% at the end of 2011, according to the most recent figuresfrom Towers Watson, an investment consultancy.
Domestic bond holdings were higher at around 95%; total pension fund assets stood at $16.08 trillion (€11.95 trillion).
The widely broadcast notion that emerging market growth can be tapped through S&P 500 earnings might also be a potential hindrance to pension plans making direct emerging market investments.
However, there are signs that things are tentatively changing.
Craig Horvath, global head of consultant relations at Dimensional Fund Advisors, a firm based in Austin, Texas, says: “There is a willingness now for public plans to look at emerging market equities and invest with dedicated managers in a standalone mandate rather than part of a wider benchmark.”
The Wyoming Pension System (WPS) appointed AllianceBernstein to a passive value-weighted emerging markets mandate last year. The $6.5 billion plan is also willing to raise its emerging market equity allocation from the current 5% to 6% as opportunities arise, says John Johnson, the chief investment officer.
“There has been a lot of discussion about emerging market opportunities but we [the industry] are not seeing assets go in that direction,” says Johnson.
“If you look at the macroeconomic dynamics of the emerging markets versus the developed world… the region is worthy of investment, especially over the 20-year period that we enjoy.”
The overhaul of the WPS investment approach (see page 12) saw the plan adopt the MSCI ACWI Investable Market Index as a benchmark for its enlarged passive strategy.
This is a traditional index that lists component companies by capitalisation.
The benchmark meant that the fund had an exposure to large, mid and small-cap stocks across 21 emerging (and 24 developed) markets at the outset.
As passive investment grows, it is inevitable that US investors who reference MSCI’s flagship index will build up larger positions in companies outside the US, including emerging markets. In 1969, the US formed 70.6% of the index; in 2012, it was 54%. Most of this allocation is in large caps.
However, in New York, Rob Balkema, senior research analyst in the investment division at Russell Investments, says investment in emerging markets is spreading beyond basic country and large-cap allocations as asset managers move “further down the market cap” and broaden into sector investment.
“Investors’ portfolios are under-allocated to emerging markets but they are moving in that direction,” Balkema says.
“There are global equity managers that only used to invest in developed markets but now they are ramping up on emerging markets. Around six or seven years ago you would see 2% to 3% [of Russell’s IntWorld Universe] invested in emerging markets, but it is now more in the region of 9%.”
Russell Investments operates a multi-manager business and Balkema says both US and local managers are hired to run emerging market strategies. Locations of managers range from New Jersey to South Africa.
The US will likely take a lead from more globalised institutional investors abroad.
“The Australian market gives something of a lead to the US in terms of globalising its pension funds,” says Balkema.
The asset management industry in the US is providing at least gentle pressure to pension plans to reduce their domestic exposures. For example, last October, Newton Investment Management published a paper saying that although the argument for a US domestic approach appeared to have been strengthened by good US equity performance in an uncertain environment, it is “inappropriate in terms of managing/harnessing risk” over a longer time frame.
In the paper, The case for a global approach to investing, Newton, which is based in London but owned by New York-based BNY Mellon, advocates global investing, not just in emerging markets.
However, Newton tackled the notion that the S&P 500 is an emerging markets play. For example, the asset manager points out that the S&P 500 has very little materials stocks in it, while the emerging markets MSCI index has a large materials weighting.
Though this hardly demolishes the argument, Newton also addresses a major reason for pension plan home bias: that domestic assets are needed to meet domestic liabilities.
Newton suggests that the high proportion of overseas earnings of the S&P mean these assets could be out of step anyway with liabilities.
The firm anticipates that some developing markets will provide “highly attractive opportunities” to US-based investors.
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