U.S. tax-exempt institutions haven't invested as aggressively abroad as they'd expected to, data show, in large part because they have been distracted by the strong U.S. stock market.
But despite the overall poorer performance of non-U.S. stock markets, U.S. institutions have been raising their foreign allocations.
According to a survey by Greenwich Associates, Greenwich, Conn., U.S. tax-exempt institutions expect to invest an average 14% of their assets, or $691 billion, overseas by late in 2000. That's up from 12.3%, or $493 billion, in late 1997, but less than was expected three years earlier. In its 1994 survey, Greenwich found institutions expected to have an average of 13.8% of their assets invested in foreign securities in late 1997.
Greenwich annually surveys on their investment expectations for the following three years. Last fall, Greenwich surveyed 1,605 of the largest tax-exempt institutional investors in the United States.
Rodger Smith, a partner with Greenwich Associates, linked a "big part" of the slower-than expected growth of international investing to the higher equity returns in the U.S. vs. those abroad.
The U.S. stock market's surge not only boosted holdings and proportional allocations of U.S. stocks, but also might have deterred some investors from putting money in weaker foreign markets. Moreover, compared with earlier years, institutions' overall growth rate of foreign investing should slow, Mr. Smith forecasted. He said non-U.S. stocks now comprise 17% of institutions' total equities holdings. At this level, "there is a question about how (much farther) institutions will go with their foreign allocations."
Although it's not clear what will become the natural ceiling on foreign investing, Greenwich found institutions plan to invest an average 20% of total equity holdings abroad by 2000.
Endowments continue to be the most aggressive foreign investors, Greenwich's data show. In 1997, endowments averaged 14.9% of assets invested abroad. That compares with an average 12.9% by public pension funds and 11.1% by corporate pension funds.
In the coming three years, the pattern should continue, the survey predicts. Endowments should average 16.8% of assets invested internationally in late 2000, public funds should average 15.6% and corporate funds should have an average 11.6% invested abroad.
Among institutional investors, corporate funds lag overall in their foreign investing because of their large defined contribution components.
Mr. Smith said: "38% of corporate assets are now in defined contribution plans." And averageforeign allocations differ substantially between corporate defined benefit and defined contribution plans. According to Greenwich Associates, corporate defined benefit plans now average 16.2% of total assets invested abroad, vs. 3% by defined contribution plans.
By 2000, corporate defined contribution plans should have an average of 4% of their assets in non-U.S. holdings, while corporate defined benefit plans should average 16.6% invested abroad, the survey found.
Big funds moving ahead
Looking into the first half of this year, experts debate how much institutions will increase their foreign investments. Most likely, institutions' behavior will vary with their appetite for risk. While some may speed their move toward a target foreign allocation - in order to grab cheaper prices in foreign markets - others might delay more overseas investing until market upheavals subside.
Some funds clearly are moving ahead with foreign investing plans. For example, in the first quarter, the $8.8 billion State Universities Retirement System of Illinois, Champaign, will raise its international equities allocation to 20% from 17.5%, said John R. Krimmel, associate investment officer.
To reach that goal, the fund plans to raise its allotment to Martin Currie Investment Management, Edinburgh, Scotland, by $50 million to $326 million. All of that $50 million is earmarked for emerging markets equities. In addition, the fund plans to add an active international equity portfolio - of stocks in developed and emerging markets - of $125 million to $150 million. Funding will come partly from cash and partly from a reduction in a passively managed U.S. equity index fund.
Two New York City pension funds also have boosted their foreign allocations, among other changes.
In its new asset allocation, the $34 billion New York City Employees' Retirement System now has a 13% weighting to international equities of countries represented by the Morgan Stanley Capital International Europe Australasia Far East index of developed markets. That's up from the previous 10% allotment to EAFE stocks. The $14 billion New York City Police Pension Fund now has a 19% allocation to EAFE stocks, up from the prior 12%; and 4% in emerging market equities, vs. 3% previously.
In dollar terms, this means the NYCERS fund expects to invest just more than $1 billion more in EAFE-type equities. In turn, the police fund will invest another $980 million in EAFE stocks and another $140 million in the emerging markets. Funding will be phased in through the year, said Deputy Comptroller Jon Lukomnik.
In December, the $9.3 billion Los Angeles Fire and Police Retirement Fund started a search for an EAFE manager for a $300 million to $400 million assignment and might seek an emerging markets manager. No decision has been made on whether to search now for an emerging markets firm or wait for completion of an asset allocation study, expected in mid-1998.
Some international money managers are putting a hopeful face on the outlook for 1998. They recognize that Asian market tumult squeezed overall international equity returns. But this year, some think conditions finally could allow foreign markets to outperform.
"The jury is still out on the impact the Far East will have on the U.S. market" this year, holds Mark Ahern, a principal at the management firm of Clay Finlay Inc., New York. But "there is already talk of earnings downgrades" of U.S. companies as a result of the Asian crises. "If this does come through, we might see the U.S. market in a challenging period, which in some ways would be positive for international markets," said Mr. Ahern.
In terms of new business, international manager searches were "fairly slow" in the fourth quarter, said Mr. Ahern. But he expects that to change.
"We all should be prepared for a ramp up in activity in the first quarter, especially" for emerging markets investments. That would include "searches that had been sidelined in the third and fourth quarter and new searches responding to opportunities from (1997's) market turmoil," he said.
Churchill Franklin, senior vice president of Acadian Asset Management, Boston, found it "remarkable that there is (this) much continuing interest in non-U.S. investing." Acadian is seeing "a significant amount of cash flow from clients" for both non-U.S. developed and emerging markets, he said. "Probably half of our 40 clients significantly increased their cash flow" in 1997. In addition, last year, the international manager landed "two or three" assignments from large new clients. Acadian targets the larger institutions, said Mr. Franklin.
Two main reasons for the higher foreign allotments by Acadian clients: the desire for investment diversification and "the reversion to the mean argument," said Mr. Franklin. As he explained, while "the U.S. market is expensive, non-U.S. stocks are cheap. But this outperformance of the U.S. market can't go on forever." Eventually, some managers believe, the underdogs will have to prevail.