More than 40% of pension executives responding to a Pensions & Investments survey said they planned to increase assets invested internationally in 1995.
Almost one-third said they would increase their allocations to emerging markets.
However, the pension plan sponsors won't be making any seismic shifts in their asset allocations in 1995, although they will be making adjustments within classes.
The survey, which polled sponsors of the 1,000 largest pension funds in the United States, found very slight shifts among broad asset classes. The average equity commitment will rise almost imperceptibly to 55.8% from 55.4% in 1994, while fixed-income commitments will drop by the same amount to 33% of assets. Cash will fall the most to 2.5% from 4% of assets, and real estate will increase to 4.2% from 3.6%.
The survey asked sponsors for an asset mix breakdown as of Sept. 30, and predicted breakdowns for the same date in 1995. Complete responses were received from 155 pension executives, a 15.7% response rate.
Sponsors also were asked to name investment vehicles they now use and how popular they will be in the coming year. The results were mostly predictable, pointing to continuing interest in equity, particularly international and emerging market investments, as well as increased commitments to real estate.
Among sponsors polled, 41.7% plan to increase active international equity allocations, 32.1% will hike emerging markets allocations and 26.2% will invest more plan assets in real estate equity.
Ironically, real estate also was the asset class being reduced by the largest percentage of sponsors - 14.7% plan to decrease their commitment to the class. Passive strategies were next in line: 12.1% of sponsors plan to decrease allocations to indexed domestic equity and 9.6% plan to decrease passive bond allocations.
The interest in international equity investment and emerging markets is not surprising, given repeated calls for more involvement in non-U.S. markets as a diversification strategy. But the experts warn sponsors must be careful in market selections, watch market valuations, be wise to political risks involved and review their currency management strategy to find a comfort level that meets their needs.
"People are flocking to an asset class that's at the top of the performance (scale), rather than at the bottom," said Peter Canoni, managing director of equity investments at Aeltus Investment Management Inc., Hartford. He likened the mania for international equity to the discovery in the late 1980s of small-capitalization stocks, a discovery that later disappointed many sponsors, he said.
International equity markets have been driven in part by the weakness in the dollar, said Mr. Canoni. He estimated about 700 basis points of the 1,000 to 1,500 basis-point gain over the past 10 years could be attributed to the weak dollar, so dollar appreciation could eat away any gains achieved. As far as emerging markets are concerned, he favors the more dollar-linked Latin American markets over the Asian countries in case of a change in the dollar's condition.
Getting in and out of markets is always a timing question, said Janie Kass, director of investment consulting services at Kwasha Lipton, Fort Lee, N.J. One solution is to gradually phase in a commitment, carefully choosing undervalued markets so as not to bid up one's own assets or face any unexpected liquidity problems, she said.
"We're very supportive in the long term of the idea of having a significant portion of your assets - about 15% to 20% - in emerging markets, but there's a lot of volatility to it. I think some persons are going to have some experiences with that volatility that they're not going to like. Some are having them now - and that was a veiled reference to Mexico," said Drew Demakis, managing director and head of research at RogersCasey, Darien, Conn. "There may be a little rethinking of that (asset class) as these sorts of events happen."
But most institutional investors understand the political risks and investing along a long-term horizon, said Mr. Demakis. Many will hang on for the ride, he said.
"One could argue that it might be a little dangerous and a little pricey, but when you look at the world and you look at where the growth is, the U.S. is not where it's at," said Ms. Kass. It's not unreasonable to have a 20% international equity allocation and perhaps 5% to 10% of that in emerging markets, she said.
Currency always will be an issue, said Ms. Kass. Sponsors strongly concerned about the risk should review their currency strategy in light of their international exposure and decide whether and how much to hedge.
Already, active currency hedging is among the most popular investment strategies; 26.4% of respondents said they are using it, with another 18.5% claiming at least some interest. But 72.4% of respondents said they had no interest in passive currency hedging.
Hedging is an individual decision, and each sponsor has to evaluate its own currency policy, say the experts. Mr. Demakis noted hedging is more valuable for developed markets such as Japan and Germany because emerging markets are more closely tied to the dollar. Hedging in emerging markets also could become prohibitively expensive.
Closer to home, the experts relate the increase in real estate commitments to a combination of previous underinvesting, inflation concerns and improvement in what had been dismal performance in recent years.
One of the emerging trends in real estate for the next two to three years will be increased commitments to real estate, said Mr. Demakis. The valuations are more stable now and yields are more attractive relative to the bond market, he said. Additionally, real estate is considered a good hedge against rising inflation, which is now a growing concern, he said.
Sponsors are not necessarily changing their target allocations to real estate as much they are trying to stay within policy, said Monica Butler, client executive at Frank Russell Co., Tacoma, Wash. Many sponsors' real estate portfolios have been below targets because of the weak returns, and they are now taking advantage of a more stable market to bring up the targets, she said.
Not surprisingly, plans for hiring managers fall along the same lines as investment plans. The largest percentages of hirings are among equities managers, particularly international equities. And international options are the preferred addition among the 28.8% of sponsors who plan to add choices to their defined contribution plans.
Twenty-three percent of sponsors polled said their next hiring would most likely be an active international equity manager, followed by 14.1% who plan to hire small-cap value managers. Another 12.8% plan to hire small-cap growth managers.
As a group, the pension executives said they plan to hire 155 new managers within the next 12 months, while they plan to terminate 85 managers. When asked what kind of manager they were most likely to terminate, 10.2% said they would drop active core growth managers, while 7.6% said they plan to cut active core value managers.
Sponsors may be trying to consolidate and limit the number of managers at the same time they are placing limited amounts with specialized managers - such as those that run emerging markets or real estate allocations - which may offset the reductions in the core manager roster, said Russell's Ms. Butler.
Hiring practices are moving in the direction of adding more international managers, said David Eager, managing partner of Eager & Associates, a Louisville, Ky., marketing research and consulting firm serving investment managers. In a survey of sponsors done in the summer, the firm projected the total dollar value of assets invested in international and global products by defined benefit plans is projected to grow to $381 billion in three years from $215 billion. If assets are going to grow by that much, it's safe to assume hirings will follow, he said.
Eager Associates polled plan sponsors about manager preferences for international and global products and found they are likely to stay with the existing manager if the assignment is a traditional international fixed-income or equity or a global fixed income. But the sponsors are more likely to hire a new firm as a regional or country specialist, said Mr. Eager.
"Maybe they really see it as an asset allocation decision, to have the added value component that their current managers don't offer," said Mr. Eager.