Many large pension funds have increased their allocations to international equities to around 40% of their total equity exposure, taking consultants' advice to raise their international equity investments.
"We have been encouraging our clients more and more to have a strategic allocation to international equities," said Augustus Cheh, global director of investment consulting for PricewaterhouseCoopers LLP, New York.
American Airlines Inc., General Motors Investment Management Corp. and U S WEST Inc. are among the firms whose pension funds are at or close to the 40% range in international equities.
Binu George, a principal and international equities strategist at Barclays Global Investors, San Francisco, has been urging his clients to invest 40% of their total equity allocation in international equities and to invest 20% of their total international equity allocations in emerging markets.
Pension plans can reduce their overall risk by using his recommended allocations, he said, based on his calculations using the Morgan Stanley Capital International Europe Australasia Far East index and the MSCI Emerging Markets index.
"We believe a pension plan should have 10% to 20% of their total fund in international equities for diversification reasons," said Mr. Cheh. The average pension fund has anywhere from a 50% to a 70% allocation to equities, he said. If it then puts 15% to 20% of that allocation into international equities, "it comes up to be a substantial number, around 30% to 40%."
American Airlines' $5.2 billion defined benefit plan has 41% of its total $3.1 billion equity allocation dedicated to international securities. Twenty percent of that allocation is in emerging markets.
William F. Quinn, president of AMR Investment Services, Fort Worth, Texas, which oversees the American Airlines pension fund, said the fund has "a meaningful investment," in international securities.
"Long term, people will invest in line with the overall market capitalization, and if the U.S. is 50% of world markets, it will represent 50% of total stock allocation," said Mr. Quinn.
American has had the same international weighting for several years. He also noted that when emerging markets ran into trouble a couple of years ago, American kept its investments "and made money."
At General Motors Investment Management Corp., New York, international equities make up about 38% of the total equity allocation.
David Holstein, managing director in charge of international investments for the $69.5 billion defined benefit portion of the $91 billion pension fund, said international investments are 23% of the total defined benefit plan, which has a total equity allocation of 60%, with emerging markets representing 3% of the total plan assets. Mr. Holstein joined with Mr. Quinn in noting how the U.S. fits in with worldwide stock market capitalization.
"If you just looked at worldwide equity market capitalization, you'd have more invested overseas," he said.
In the end, he said, the level of international investing should be "what you're comfortable with."
"We've shown our clients if you add international equity as a strategic asset class, you can reduce your risk for the same amount of targeted return," said PricewaterhouseCoopers' Mr. Cheh.
He added there's much less resistance to international investing now than there was five years ago.
Indeed, international assets represented just 8% of total defined benefit plan assets of the 200 largest pension plans in Pensions & Investments' plan sponsor directory as of Sept. 30, 1994.
Some pension plans with no international equity allocation are now approaching PwC and asking if they should make international investments, he said.
"There's a proactive approach now," by a lot of pension funds, Mr. Cheh said, more than there was five to seven years ago.
Jeff Nipp, an Atlanta-based consultant with Watson Wyatt Worldwide, said, "there is not one answer to the question," of how much money pension funds should allocate to international equities.
He said, "liabilities come into play and different sets of liabilities can mean different answers to how much should be invested internationally."
BGI's Mr. George acknowledged U.S. pension funds have to take into account their liabilities when they set their asset allocations.
However, he believes that returns from international investments will do at least as well as, and may do better than, returns from U.S. investments, and that the risk reductions that result from diversification add to the importance of international investments.
It's an argument that hasn't had an effect on the State Board of Administration of Florida, Tallahassee, where international equity investments make up 17% of the total equity allocation, nowhere close to Mr. George's recommendations.
Scott Seery, chief of international equities at the $103 billion fund, said the international equities allocation is 12% of the total fund, up from 8% a year ago, while the overall equities allocation is 70%.
"This allocation has served us well with the performance of the U.S. stock market," said Mr. Seery.
While he understands the theory behind the recommendation for higher amounts of international equities investments, he said he doesn't think the fund will follow it.
Mr. George explained that his calculation for international investing comes from starting with an assumption of a portfolio entirely invested in the Standard & Poor's 500 stock index, which had a standard deviation of 15.36%. As an international component is added in increased in increments of 10 percentage points, using the EAFE index, the standard deviation goes down to 14% at 40% international and then starts climbing again.
Starting with EAFE
With the emerging markets investment, the calculations start with 100% in EAFE, which has a 17.2% standard deviation. At 20% invested in emerging markets, the standard deviation hits its low point of 16.5%.
The $13.2 billion defined benefit plan of U S WEST, Englewood, Colo., has 38% of its equity allocation -- comprising 64% of the total fund -- in international securities.
Kim Walker, president of U S WEST Investment Management Co., said, "I think a large fund should have a larger allocation to international. It increases the diversification and lowers risk.
Mr. Nipp said Watson Wyatt "presents a range of choices to our clients," most of which have 10% to 15% of their total assets invested internationally. He said a number of his clients are at the 20% level for international investments.
Although he said there's a fairly wide range, he said the average total equity allocation of his clients' defined benefit plans is around 65%. If you figure the total international allocation is about 15%, that means they have about 23% of their total equity allocations invested internationally. His clients who are at the 20% level for total international assets have about 30% of their total equity assets invested internationally.
Mr. Nipp said some clients are approaching 30% of their total assets in international equities but "that is a good stretch," and he doesn't think most firms would go that high.
He thinks it's unlikely to see any fund with more than 20% invested internationally.