Pension funds start building with Brics

Financil News

Jason Corcoran

24 August 2009

UK consultants advise clients to invest up to 15% in emerging markets
Emerging markets have finally gone on the pension scheme radar as the stock market boom in China and India outpaces the recovery in the west. While developed world equities have advanced by 15% this year, markets in China, Russia and India have clocked up 44%, 52% and 61% respectively.

In the absence of economic growth, western markets are starting to acquire some of the dysfunctional characteristics of developing countries, as governments agonise over the future.

Figures from global fund tracker EPFR show dedicated emerging-market equity funds took in $1.6bn (€1.1bn) in the first week of August, bringing total year-to-date inflows to $36.1bn.

Investor demand for emerging market bonds means the cost of insuring against debt defaults has fallen below western governments for the first time. Russian default swap prices, for example, have fallen to 255 basis points, or 20 basis points less than those linked to California.

Investment consultants in the UK remain cautious but none the less they are advising pension fund clients to invest up to 15% of their portfolios in emerging markets through equity, debt, currency, swaps and other strategies.

Hewitt Associates recommends that schemes should invest a maximum of 10% in emerging markets. Consultant Tapan Datta said: “The general fear factor associated with emerging markets has diminished. Their debt and equities are now on a par with developed markets.” Mercer recommends a 10% to 15% exposure and advises schemes to tap into the skills of specialist managers rather than broadening the remit of global teams.

Deborah Clarke, a principal at Mercer, said there was evidence that money has been switched out of UK and US equities into global and emerging market mandates.

She said: “We are seeing global and emerging market mandates picking up this year after going very quiet in 2008. A number of global equity managers are broadening their mandates.”

The risk aversion of pension fund trustees has historically been a factor working against increased asset allocation to emerging countries. The repeated occurrence of financial crises in countries such as Argentina, Mexico and Russia heightened perception that emerging markets were excessively volatile.

In the past, schemes in the UK and the US have viewed emerging markets as deserving their own asset class. They were seen as a sub-component of global equities, within Morgan Stanley’s All Country World Index for equities or Citigroup’s World Government Bond Index for bonds.

The upheaval in developed markets over the past two years and the reduced contagion to emerging economies suggests a greater migration of capital from the West is under way.

Mark Humphreys, a member of Schroders’ Strategic Solution group, said: “Pension funds should look at emerging markets more closely. They represent 12% of the MSCI all countries index and we expect that to increase.”

Asset managers and investment banks have been positioning themselves to benefit as emerging markets recover more quickly from the global economic crisis.

A survey by Bank of America Merrill Lynch published last week showed a net 52% of fund managers wanted to be overweight developing economies.

UK-headquartered bank Standard Chartered has raised £1bn (€1.1bn) to allow the group to expand in Asian markets. Standard chief executive Peter Sands said the group believes Asian markets will benefit from a faster recovery than the west.

Fund manager Mark Mobius plans to double Templeton Asset Management emerging-market assets to $50bn within two years. China is the top Mobius pick. Other managers see the country as a catalyst to a global recovery.

Jerome Booth, head of research at Ashmore Investment, has caused waves with his recent suggestion that investors should increase their level of exposure to emerging markets to between 35% and 50% based on the share of global GDP.

Long-only managers and emerging market specialists said Booth’s allocation is excessive and would blow a hole in pension scheme risk budgets.

Bill O’Neill, a portfolio strategist at Merrill Lynch Global Wealth Management, said: “Fifty per cent is way beyond what funds should be putting in. We think 12% should be a starting point. The story is right but the key problem is that the opportunity was more compelling early in 2009 when emerging markets were seriously undervalued.”

Aviva Investors supports Booth’s views in terms of how he has highlighted the potential for emerging markets, relative to developed markets, to contribute more substantially towards portfolio outperformance.

It believes that as emerging markets are growing, developing and arguably maturing, investors need to take a more sophisticated approach to tapping main growth markets.

Instead of allocating on a country or regional basis, Aviva makes the argument for using different emerging market styles. Aviva recently reorganised its emerging markets team on this basis, and instead of having regional experts it has managers dedicated to emerging macro, emerging special situations, emerging small cap, and so on, with the aim of delivering greater alpha.

Baring Asset Management is cautious on developed markets. Percival Stanion, head of asset allocation at Baring, said pension schemes should be downsizing their structured weightings to developed markets.

He said: “The industry is seeing a big ramp-up in searches and appointments in the UK and the US for emerging markets mandates. We have about 25% of our portfolio invested in emerging markets, which would be considered aggressive elsewhere.”

Baring stresses that emerging market portfolio exposures should depend on client risk appetites. But it believes investors’ allocation to emerging markets should, on a long-term strategic basis, be about 20%.

In multi-asset portfolios, Baring can argue that you need an investment manager that can tactically manage this exposure to emerging markets as conditions dictate, rather than maintaining a certain level of exposure at all costs.

Jonathan Harrison, global head of research at UBA Capital, the investment arm of the United Bank for Africa, recommends pension funds commit 40% to emerging economies.

He said: “Developing markets are, almost by definition, growth leaders and therefore more attractive investment destinations than developed markets. The global crisis has not altered the fundamental thesis but has illustrated that it is not only developing markets that are prone to periodic economic earthquakes.”

Swiss private bank Lombard Odier Darier Hentsch said allocations stretching to 50% are neither realistic nor pragmatic. Curtis Butler, head of emerging market equities at Lombard, said many inflows were a reaction to the correction from last year’s slump.

He said: “We believe in gradually increasing exposure. Emerging markets have not yet achieved the stability on an annualised basis. We need to see another decade of stability. There are still those who see emerging markets as a fair-weather friend but they have not yet learned to have them as a permanent place in their portfolios.”