NEW YORK - U.S. pension funds are expected to double their international exposure in the next six years in pursuit of higher returns, according to experts at the P&I fifth annual World Congress on Global Investment Management.
"Most U.S. funds are the most provincial in the world," said P. Craig Ueland, international operations director of Frank Russell Co., Tacoma, Wash. He said that if a fund has "less than 15% overseas, please review your allocation; over the long term nothing else you do will have as much effect" on returns.
And if history is a guide, funds will be rewarded. According to Mr. Ueland, the Morgan Stanley Capital International Europe Australasia Far East Index outperformed the U.S. market in 15 of the 16 10-year periods since EAFE was created in 1969.
Over the 10 years ended Dec. 1993, international markets have outpaced the U.S. market by an annual average of 370 basis points.
Edgar W. Barksdale, president of RCB International, Stamford, Conn., illustrated how "international investing" can be "key to achieving your goals."
Mr. Barksdale presented several investment scenarios ranging from very basic to very sophisticated. In these extremes, his data showed that at one end of the spectrum, a simple portfolio invested 60% in large-capitalization U.S. stocks and 40% in bonds produced a 10-year annual return of 9% and a standard deviation of 4.3%. The most complex portfolio he presented - which had 25% in international stocks, equal amounts of U.S. large- and small-cap stocks and 30% in bonds - produced a 10-year annual return of 10.8% and a standard deviation of 5%.
Messrs. Ueland and Barksdale also urged pension executives to use specialized international mandates. "Clearly, the great knowledge is in the hands of the local specialist, and you go against them at your own peril," Mr. Barksdale said.
Finding the correct benchmark for international stock investments can be tricky. While many U.S. pension executives use the market-cap weighted EAFE index, some look to a gross domestic product-weighted index that better reflects countries' economic growth. The problem with the GDP-weighted benchmark, noted Steven Rothmann, investment manager at PanAgora Asset Management, is that liquidity drops off significantly.
Alternative benchmarks, such as a "minimum risk" benchmark, which seeks the lowest possible correlations with U.S. stocks, also sacrifice liquidity and may generate significant turnover, Mr. Rothmann said.
Cynthia Steer, director of United Technologies Corp.'s $12 billion in retirement assets, said pension executives should be less concerned with picking the right benchmark and more concerned with studying massive global economic changes.
New sources of savings, cashflows and demands for capital are rapidly changing the ground rules. Benchmarks, which typically reflect historical trends, are less relevant in this environment, she said.
"I think it's a great time to make money. It's probably a crappy time to play by the rules," Ms. Steer said.
Corporate pension funds are too thinly staffed to keep up with the rapidly changing economic developments, she said. Ms. Steer appealed to Wall Street to provide more information on changing developments.
In-house management was scrutinized for its potential to cut costs and better control investments. Indeed, the $14 billion pension fund of NYNEX Corp., New York, is now about 20% internally managed, with a small portion of that invested internationally - although that portion is expected to grow, said Audrey Kent, managing director of Nynex Asset Management Co. She pointed out that internal management "increases control over asset allocation."
The $20 billion (Canadian) Ontario Municipal Employees' Retirement System, Toronto, is about 75% internally managed, but North American equities is one asset class managed externally, said Sam Wiseman, portfolio manager-external funds.
In mid-1993, the fund decided against handling international investing in-house for any additional allocations made. Reasons included questions as to whether in-house managers could outperform external managers; expectations that this staff's knowledge would only be "marginally" useful to the rest of the fund; and fears that the international managers might be lured away to other organizations.
However, the policy doesn't apply to non-Canadian government bond investing. This year, the Ontario fund received board approval to manage in-house investments in the top-rated government debt of five countries: Japan, Germany, France, the United Kingdom and the United States.
Mexico and France
A range of experts - including Alejandro Valenzuela, director of public debt in Mexico's Department of Finance, and Antoine Merieux, financial counselor with the French Embassy - addressed specific investments.
Mr. Valenzuela outlined Mexico's array of economic achievements - lowered net total public sector debt, the nearly 950 companies that have been privatized, plunging inflation since the mid-1980s (the consumer price index was only 6.7% in September) and a strengthening financial sector. The capitalization of Mexico's $260 million stock market is now almost 60% of GDP; it's now the world's eighth largest stock market.
France's Mr. Merieux pointed to improving economic conditions in his country. But as 1995's presidential elections approach, the big issue will be addressing unemployment, he said.
The French stock market is seen as an area which could contribute to overall economic improvement. In the first nine months of 1994, new issuances totaled 62 billion French francs, twice the volume in all of 1993. And there now are more than 1,000 listed companies in there, which represents all business sectors, Mr. Merieux said. The number of retail investors has jumped 27% in the last two years to six million, and volume has doubled in the two years to the beginning of 1994 to $1 billion a day.
Other measures designed to bolster France's market include new corporate governance rules, more favorable withholding tax arrangements with countries with whom France has tax treaties and the expected development over time of company pension funds, Mr. Merieux said.
Around the world
In other regions, Japan was embarking on a "fiscal-led U-shaped recovery," according to Anna Tong, managing director, Aeltus Investment Management Inc., Hong Kong. Although sluggish, Japan's economy should show improvement, with growth averaging 2.5% to 3% over the next several years.
Hong Kong's 5.5% economic growth level over the last two years would likely be repeated next year. However, over the next six to nine months, expectations of continuing rises in U.S. interest rates bode badly for the Hong Kong market because the Hong Kong dollar is pegged to the U.S. currency.
In Taiwan, Ms. Tong said the economy is maturing, with growth expected to be about 6% in the 1994-'95 period, compared with growth rates of about 8% earlier.
As a market comparison, Ms. Tong forecasted corporate earnings per share growth of 30% for Japan, 15% for Hong Kong, 15% for Taiwan and 12% to 15% for Chinese "B" shares. For 1995, market price-earnings ratios should include 59 for Japan, 10.8 for Hong Kong, 28.7 for Taiwan and 10 to 13.5 for Chinese B shares, said Ms. Tong.
The South African stock market is booming, said Thomas Bacon, vice president for research and sales at SAICOR Securities Inc. One of the world's 10 largest stock markets, its all-share index was up 19.8% through Nov. 4 in local currency terms. Also, the market will be incorporated into indexes run by the International Finance Corp. and Morgan Stanley Capital International as it returns to the international marketplace.
Globally, small-cap stocks are grabbing more investors' interest. In a nutshell, the sector still enjoys some of the basic attractions that drew investors overseas in the first place. These include: a much large number of listings proportionately than in the large cap sector; a lack of research on the sector; and relatively attractive valuations compared with larger cap stocks.
As of 1993, the largest 25% of non-U.S. companies had an average price-earnings ratio of 28.1, while the smallest 25% had a p/e of 20.1, said John Reinsberg, general partner of Lazard Freres Asset Management, New York. Also, the largest 25% of non-U.S. companies had an average price-to-cash flow ratio of 12.2 vs. 8.9 for small caps; and on the basis of price-to-book ratio, the comparisons were 2.4 for the largest non-U.S. stocks, compared with 1.4 for the smallest, he said.
But he and other speakers acknowledged the downsides in investing in small caps: limited trading liquidity, lack of information on the companies, possibly creative accounting and limited disclosure by companies. Moreover, overall market moves - including downside moves - may be more exaggerated in the small-cap sector.