William M. Mercer and Frank Russell are the latest U.S. consultants to fine-tune their thinking about -- and thus their clients' potential exposure to -- emerging markets.
William M. Mercer Investment Consulting Inc., Chicago, is considering dropping emerging markets as a separate asset class.
At Frank Russell Co., Tacoma, Wash., executives are thinking about dropping the International Finance Corp.'s stand- alone investible index as a benchmark for money managers given broad international mandates. Russell then would adopt a unified international benchmark that includes non-developed markets.
For specialist emerging markets managers, however, officials said they would continue to use the IFC index.
Ennis, Knupp & Associates, Chicago, and Wilshire Associates Inc., Santa Monica, Calif., adopted such an index last year -- the Morgan Stanley Capital International All Country World Index ex-U.S. The benchmark has a market-capitalization weighting for emerging markets stocks.
Each move is a way for clients to have a wider variety of emerging markets stocks in their portfolios.
The Russell and Mercer changes also would allow money managers to move strategically into developing markets.
Regional managers, for example, could expand their portfolios from developed markets to neighboring emerging markets, said Andrew Rasmusen, a principal with Mercer.
"Benchmarks help identify the investible world," said Russell's Monica Butler, director of U.S. consulting. "We're always out there, looking for better benchmarks."
Some money managers that run portfolios that use the MSCI Europe Australasia Far East index as a benchmark long have had license to invest a set amount -- perhaps 5% or 10% -- in emerging markets.
"Historically, we have thought of it as a separate asset class," said Mr. Rasmusen, who was speaking from a client conference in Arizona where the possible changes were discussed.
Mercer is "having some internal discussions about asset allocation issues in general, and an issue on the table is whether it still makes sense to treat emerging markets as separate. Generally speaking, we do, but we have the issue under study," Mr. Rasmusen said.
For clients investing regionally, it makes sense to consider treating emerging markets as part of their developed markets, regional portfolio, he said.
He compared the idea of folding emerging markets into a global equity program with incorporating U.S. small-cap stocks into a broad domestic equity portfolio.
The advantage of ACWI, observers say, is investors can make consistent and self-rebalancing allocations to emerging markets rather than fixed strategic allocations of assets.
The move to drop emerging markets as a separate asset class is related to the development of benchmarks.
"Now with ACWI, you have a customized benchmark. In the past, emerging markets was viewed as a separate asset class," said Kathleen Dunlap, managing director and head of consultant resource group with Barclays Global Investors in San Francisco.
Ennis, Knupp last year "adopted ACWI for a fair number of clients," said Sue Rutherford, a principal. "It's best for clients who have a streamlined program" with core active EAFE managers that have license to invest 10%, 15% or 20% in emerging markets.
Some in emerging markets
Like domestic bond managers that may invest a percentage of a client's portfolio in high-yield bonds, "EAFE-plus" managers may invest a percentage of a portfolio in emerging markets.
"ACWI is the ideal benchmark to keep" EAFE-plus managers more honest, she said.
If such managers are compared with the ACWI benchmark rather than with EAFE, "the extra risk of investing in emerging markets is not ignored," she said. "It also offers a better return comparison."
Active international managers can drastically outperform or underperform the EAFE benchmark because of their emerging markets weighting, Ms. Rutherford said.
Many Ennis, Knupp clients with EAFE-plus managers have adopted the MSCI ACWI ex-U.S. index, she said.
Frank Russell is considering switching to a single international, market-cap weighted benchmark from the two benchmarks.
Russell always has recommended its clients take cap-weighted positions when investing in emerging markets, said Grant Gardner, director of research, capital markets.
Tailored benchmarks
But the company now recommends tailoring the benchmark to client needs, said Ms. Butler. For many investors, Russell recommends some clients blend two benchmarks -- the IFC investible index and the Salomon Broad Market index -- to form an international benchmark that includes stocks in developed and non-developed countries.
This month, executives from Russell are meeting with MSCI representatives to talk about the ACWI index. Russell also plans to meet with its current indexer, Salomon, to discuss Salomon's yet-to-be-launched international market-cap benchmark.
The change would help Russell clients that rebalance portfolios when emerging markets swing up and down.
"Some clients are struggling because a weighted benchmark requires too much rebalancing," said Ms. Butler.
Russell, however, clearly thinks Salomon's index captures more stocks than MSCI's, she said.
"Salomon has a more complete coverage of world capitalization," she said. "There are more mid- and small-cap stocks in Salomon than in MSCI."
The potential change is part of the company's effort to "always look for a representation of an asset class," she said.
She compared the development of broad international cap-weighted benchmarks with the move from the Standard & Poor's 500 index to the Russell 3000 and the Wilshire 5000 indexes.
No clear consensus among pension fund executives, consultants and money managers has emerged on the issue of dropping emerging markets as an asset class. Some consultants within the same firms disagree.
Wary managers
Investment managers and pension fund executives gave mixed assessments of whether pension funds are ready to invest again into emerging markets, which have experienced a roller coaster ride this decade.
Consultants are not advocating their clients stop investing in emerging markets.
Far from it. After a disastrous 1998, emerging markets have rebounded this year.
The MSCI emerging markets free index was down 21.3% during the third quarter last year, up 17.4% in the fourth and up another 12% in the first quarter of this year. It added another 12% through April 28.
In the third quarter last year, the MSCI EAFE index fell 14.6%. In the fourth quarter it rose 20.2%. In the first quarter of this year, it was flat.
Over the same periods, the MSCI ACWI ex-U.S. index fell 15%, rose 20% and was relatively unchanged by the end of March.
The ACWI ex-U.S. index has an emerging markets weighting of 10%.
