Some institutional investors have learned a lesson from the shocks to which a broad emerging markets allocation can expose them.
According to its fiscal 2013 annual report, Princeton University's $18.7 billion endowment fund changed the way it invests in emerging markets.
In the 10 years ended June 30, 2013, the fund's emerging markets allocation returned 17.5% against a benchmark return of 13.9%, according to the report.
“Emerging markets produced the highest absolute return of the endowment's asset categories, despite suffering through a sharp decline during the 2008-2009 financial crisis,” the report said. ”The strong performance would not have been possible without the shift in our emerging markets manager roster over the last decade, from employing generalist managers to investing primarily with foreign-based, single-country and regional specialists,” the report said. Spokesmen at Princeton did not respond to requests for comment.
“Our view would be that (a global basis) is probably the best way to go,” said Gareth Anderson, London-based senior consultant on the manager research team, focusing on equities, at Mercer. “If you are looking particularly at emerging markets, some of the positives of having single country or a regional approach is having feet on the ground, which can give access to companies. Having people speaking the language and understanding cultural nuances helps to do company research.
“What we think works best and aligns with academic evidence is managers that run strategies with a high active share, are not too constrained, not too dependent on benchmarks, who tend to do better. By having the largest possible investment universe as a starting point gives the best opportunity of having a higher active share.” He said a Russia or Eastern European-specific index could have a 20% allocation to one company alone. “We tend to see that managers running country-specific mandates find it very difficult to run unconstrained mandates, as it can be harder to generate a high active share against very concentrated benchmarks.”
Mr. Anderson said endowments would be better placed to run these types of allocations, whereas pension funds do not necessarily have the governance resources in-house. He has not seen U.K. corporate pension funds investing away from a broad emerging markets allocation.
Likewise, U.S. pension funds are not investing in single-country emerging markets funds. “Most focus has been on getting emerging markets exposure — that is a big step as a lot of U.S. institutional clients still have only 5% invested in emerging markets, whereas the market cap of these countries is something like 11%, and these markets represent a third of total world GDP,” said Iain Douglas, investment consultant, head of Asia ex-Japan equity manager research and part of the global manager research team at Towers Watson & Co. in New York. “Pension funds are underweight to where we think they should be.”
However, some experts have seen segmenting of emerging markets. “We have seen increased interest in segmenting emerging markets by geography, size or sector and interest in certain themes (such as emerging markets consumer),” said Mike Orzano, associate director, global equity indexes at S&P Dow Jones Indices, based in New York. “The vast majority of investors continue to access emerging market equities through index-linked products tracking traditional, capitalization weighted benchmarks or through active managers with mandates closely tie to these same benchmarks.”
This article originally appeared in the March 17, 2014 print issue as, "Some investors prefer a more individual approach".