NEW YORK - How much should a "prudent but performance-demanding investor" allocate to emerging markets?
Barton M. Biggs, chairman, Morgan Stanley Asset Management Inc., says a "typical global balanced portfolio like a pension fund should have at least 26% of its assets in emerging markets," in a new report to clients.
Contrary to common international equity mandates by U.S. fiduciaries of putting half of the portfolio into the countries of the Morgan Stanley Capital International Europe Australasia Far East Index and half into emerging markets, Mr. Biggs says he would skew such a mandate to 70% to 80% emerging markets.
"Emerging markets are where the potential is," he adds. "If you acknowledge this, but don't make the bet in a big way, you are going to be eating your words on toast."
Of those emerging market assets, he would allocate 70% to equities, 25% to debt and 5% in direct investments. He says the allocation also should include real estate, although he gives no specific share for it.
Fiduciaries, he acknowledged, must be concerned with risk and liquidity. But he suggests emerging markets aren't much more volatile than mature markets.
For the past 10 years, he said emerging market equities have had a standard deviation of 27.9%, the highest of any asset class Morgan Stanley analysts follow. But he notes the EAFE index has a standard deviation of 26.9%, while U.S. small stocks and U.S. emerging growth stocks amount to about 18.5%.
"(E)merging market equities and fixed-income paper are risky and volatile, but they are not illiquid," he says.
Investments in high potential assets like real estate opportunity funds, venture capital, leverage buy-outs and private investments have lower standard deviations but are much more illiquid, he says.
Emerging market equities alone at the end of 1993 totaled 11.6%, or $1.6 trillion, of the world's $14.1 trillion stock market capitalization, while emerging market debt amounted to less than 5% of the world's fixed-income assets.
But he says investors should not limit emerging market allocations to market weighting. Mr. Biggs said investments should be opportunity oriented, rather than driven by market capitalization.
Market capitalization weighting schemes resulted in EAFE-mandate investors keying off of the index weight of 65% in Japan in the fall of 1989, when the Japanese gross domestic product weight was only 32% and just before the stock market there lost two-thirds of its value, he adds.
"If you are going to think indexes, GDP weights probably make more sense," Mr. Biggs says.
