In 1974 the door to international investing reopened and pension funds obligingly filed through it.
Corporate pension funds started examining non-U.S. securities as far back as 1958, when U.S. Steel Corp.'s vice president of investments, Harvey Moule, encouraged his staff to seek common stock investments overseas.
The fund, which had been one of the first to invest in U.S. common stocks, chose a Hitachi convertible issue as its first non-U.S. investment.
U.S. Steel invested in similar issues by other Japanese companies until the Interest Equalization Tax was imposed in 1963. The tax reduced the outflow of dollars into foreign investments by reducing the returns on foreign investments, particularly fixed-income investments, to rates comparable to those available in the United States.
This changed when the tax was lifted by President Nixon in January 1974, reopening the doors to international investing. But the road was still not clear. ERISA seemed to prohibit, or at least make questionable, international investing, because the law required that "the indicia of ownership" -- the stock and bond certificates -- of fund assets remain within the jurisdiction of federal courts.
International investing by pension funds got a second boost in 1974 when the Financial Analysts' Journal ran an article by Bruno Solnik, assistant professor of business at Stanford University, that examined the correlations between U.S. stocks and non-U.S. stocks. Mr. Solnik found that diversified international stock portfolios were likely to carry less risk than diversified domestic equity portfolios. This paper and others that followed established the intellectual framework for international diversification by U.S. investors.
In the middle of the bear market of 1973-'74, pension funds and money managers began looking for other investments, particularly non-U.S. stocks. Although some markets had followed the U.S. market down, especially in the immediate aftermath of the oil crisis, not all did. Even among those that did, not all were hit as hard as the United States, and some recovered more quickly. Besides, some investors had noted there were quality non-U.S. companies that were highly competitive with U.S. ones.
Following the lead of U.S. Steel and, a few years later, General Electric, money managers had begun investing in non-U.S. securities for the U.S. pension fund clients in the '60s.
One of these was Capital Guardian Trust, which was a beneficiary of the hiring, by the Capital Group, of a young man named Ken Harrison Mathiessen-Gerst. Mr. Mathiessen-Gerst wanted to leave New York for Switzerland, and Capital Group arranged for him to open an office in Geneva in 1963.
The idea was that besides researching European companies, Mr. Mathiessen-Gerst also could keep an eye on U.S. companies such as General Motors and International Business Machines, which were beginning to draw significant parts of their earnings from Europe. By the early 1970s, many Capital Guardian pension clients had non-U.S. stocks in their portfolios.
Like the Capital Group, Morgan Guaranty had been seeking and buying quality non-U.S. stocks for some of its pension clients on a selective basis since the 1950s. And believing that international investing was the right thing for investors, Morgan had established an international equities commingled fund "for future use" in late 1974.
The fund had been started by Harrison Smith, head of Morgan's pension investment department. Mr. Smith appointed Karl Van Horn as the fund's first portfolio manager. Mr. Smith believed international equities offered diversification and risk control, the point made by the Solnik article, and believed all of Morgan's pension clients should be diversified internationally.
Mr. Smith believed international investing would help fulfill ERISA's mandate that pension funds be diversified, and he believed ERISA would not prohibit trust banks from investing their clients' assets overseas because most large trust banks had offices in the major countries.
In November 1974, armed with a legal opinion that international investing was allowed under current law, Mr. Smith had Mr. Van Horn write a letter to all of Morgan's more than 400 clients for whom it had full discretion saying that if they did not object in writing, Morgan would put 1% of their funds' assets into international securities beginning Jan. 1, 1975. There was almost no objection from clients.
"The whole issue was making country bets," Mr. Van Horn said.
"There were no sector bets. You had to decide whether to be in a market, or out of it, and if you were in, then you bought the liquid stocks."
The first year the fund was up 40% in dollar terms. The next year it was up 70%, and by 1978 it had grown to more than $800 million.
While Morgan was quietly acting, most trust banks were waiting for the Labor Department's approval.
First National Bank of Chicago had established its international commingled fund, Fund G, in fall 1974 with a token $1 million, but was awaiting DOL clearance before actively marketing it.
Likewise, Fiduciary Trust Co. of New York also was holding off marketing its fund until the Labor Department ruled.
They would wait, however, until mid-December 1976, when the Labor Department issued a proposed regulation that allowed the "indicia of ownership" to be held by the offshore offices of U.S. trust banks.
Not all pension funds were rushing in to international investing.
Gary B. Bland, manager of trust investments at Boeing Corp., told Pensions & Investments in October 1975 that: "It's hard enough to know about your own markets; when you start talking about foreign investment, you have to hire somebody who is a specialist."
And Norman B. Williamson, assistant treasurer at FMC Corp., said: "There are values over there and also here, but you can identify value better here."
In 1975, InterSec Research Corp. was established by Chris Nowakowski to supply research and other services to those investing internationally.
Polish-born and Canadian-bred, Mr. Nowakowski spent 12 years with the Canadian brokerage firm Wood, Gundy Inc. before deciding to set up his own shop.
InterSec provided guidance on international investing to both pension funds and money managers, and proved to be a strong advocate of international investing.
In addition, the firm kept track of how much money U.S. pension funds invested overseas and which funds had done so. Its reports about how much was being invested overseas helped stir other funds to make the plunge.
As many consultants and money managers had found over the years, except for a few pioneering pension fund executives, the first question most fund executives asked when presented with a new idea was: "Who else is doing it?"
InterSec was able to answer that question.
At the beginning of 1980, U.S. pension assets invested internationally totaled $3 billion.
But the pattern for a new surge overseas was set as the $2.1 billion General Telephone & Electronics pension fund appointed three new international managers, for a total of 10, boosting its international allocation to almost $200 million.
A few months later, the Board of Pensions of the United Presbyterian Church committed $20 million of its fund's $500 million in assets to the Templeton World Fund, becoming one of the very few pension funds to use a mutual fund to invest.
And in May, executives of the $700 million Sun Co. Inc. pension fund hired four international managers to invest $35 million.
"The rationale behind international diversification is an attempt to dampen the fund's volatility.
The markets don't all move in unison; they tend to have different cycles," said E. B. Warwick, manager of employee investment funds at Sun Co.
Mr. Warwick was an early convert to the academic reason for investing overseas.
In addition, he said, "we want to beat inflation. We think we have a better opportunity to do so by diversifying internationally."
As the year wore on, many more funds made the plunge into international equities or boosted their existing commitments, and by the end of 1980, assets invested internationally had surged to $5 billion.
International investing remained an area of great interest for pension funds throughout the decade, and the growth was phenomenal.
By the end of 1985, the total assets invested overseas by U.S. pension funds was close to $26 billion and, only six months later, had climbed to $32.6 billion. Commitments to international investment surged 43% in 1989 as public employee pension funds joined corporate funds in venturing overseas. And the assets grew another 22% by the end of 1990.
Some of the pioneering funds and managers were beginning to invest outside of the major European markets and Japan and into some of the emerging markets. One survey found 35% of the international management assignments in 1990 were for investment in emerging markets.
Among the emerging markets being explored in 1990 and 1991 were the former Communist-bloc economies, freed when the Berlin Wall crumbled in 1989.
Dean LeBaron of Batterymarch Financial Management began trekking to the Soviet Union, at the invitation of Soviet officials, after Mikhail Gorbachev expressed willingness to allow companies to be privatized.
After developing contacts in the Soviet Union and identifying companies that seemed efficient enough to survive and compete within the Soviet bloc, and even outside of it, Mr. LeBaron began to put together the Russian Companies Fund.
By July '91, he had several large corporate pension funds prepared to commit to investing in it, but in August 1991 Boris Yeltsin came to power, and all of Mr. LeBaron's contacts lost their positions.
In addition, the political and economic outlook for what had now become Russia and a host of new countries was so uncertain that Mr. LeBaron felt he could not carry forward with his fund.
Meanwhile, George Russell of Frank Russell Co. had put together a group of 20 large pension funds and 20 large investment management organizations to explore investment in emerging markets.
The so-called 20-20 Group made its first overseas journey in June 1991 to the newly free countries in Eastern Europe. It later made exploratory educational trips to Japan, China and emerging markets in Southeast Asia.
Two other organizations became involved in educating pension executives to the investment opportunities overseas, particularly public pension fund executives.
These were the Institute for Fiduciary Education and Pensions 2000. Both groups arranged for money management firms to pick up most of the costs for pension executives traveling on these educational and "kick-the-tires" expeditions to Eastern Europe, Latin America, Japan, China and Southeast Asia.
Partly as a result of these efforts, but even more because of the strong investment results, international investment by pension funds -- especially public pension funds -- increased dramatically during the early part of the decade.
Between March 1993 and March 1994 alone, the assets invested internationally for U.S. tax-exempt institutions, mainly U.S. pension funds, increased by 52%, with market appreciation accounting for less than half of that gain. And despite the poor results in 1994, funds continued to pour assets into foreign markets.
The money flows from U.S. pension funds helped further the development of the capital and stock markets in the emerging countries in Asia and South America.
The funds were attracted to the apparently high growth rates of countries such as Thailand, Taiwan, Singap