Pension funds are starting to take a truly global approach to their investments.
More plan sponsors are paying attention to the global issue now because companies have business divisions in many countries and derive revenues from more places than just their country of domicile. As industries go global, industry factors become as important, if not more so, than country factors in terms of portfolio return, according to Jeff Diermeier, global chief investment officer of UBS Global Asset Management, Chicago.
"If I had a choice between making an (investment) choice based on a global sector or on a country basis, I'd make it on the basis of sector shifts in this economic landscape," said Mr. Diermeier. "Industry-related shifts will benefit companies and countries."
Indiana Public Employees' Retirement System, Indianapolis, is one U.S. pension fund sticking its toe into the waters of globalization. It is allocating 6% of its $10 billion fund to an active global equities strategy, taking 3% from its domestic U.S. equities portfolio and 3% from international equities investments, which will total about $500 million.
"We believe if we hire global managers as opposed to domestic or international that we can add alpha to our fund," said Patricia Gerrick, chief investment officer.
Ms. Gerrick said the fund is looking for global managers who have concentrated portfolios with 40 to 60 stocks and high information ratios. "We believe global mandates drive outperformance," she said.
The money will be split evenly between growth and value strategies. The Indiana fund expects the global portfolio to outperform its benchmark by 350 basis points with a 7% tracking error.
Hedge fund format
UBS has been managing global equity portfolios since 1981 and now has about 50 clients with about $3 billion in its global equity strategy.
Mr. Diermeier said the firm uses "a hedge fund format" so it "will not be confined to the long side; we will be able to short securities" and work for clients who are interested in absolute returns.
"At the core, it's global investing. The question is whether or not short-selling is allowed," said Stefano Cavaglia, executive director and head of equity strategy at UBS Global.
Mr. Cavaglia was a co-author of a 2002 study that found global industry factors are more important in stock selection for international portfolios than country factors. It concluded home-biased portfolios in countries with highly concentrated industrial structures (Finland, Australia, Switzerland) are particularly inefficient as they provide poor diversification across industry factors.
Active allocation must permit asset managers to undertake security trades within an industry across countries (example: buy Fiat SpA, sell Toyota); this implies that a global portfolio is superior to a collection of regional portfolios, according to the study.
The study, "The Increasing Importance of Industry Factors," by Mr. Cavaglia, Michael Aked, executive director and head of asset allocation and risk management in the Asia/Pacific region for UBS Global, and Christopher Brightman, senior vice president at Greenwich Capital Markets, Greenwich, Conn., was published in the September-October 2000 issue of the Financial Analysts Journal.
UBS in talks
UBS is in discussions with the giant Dutch pension fund Stichting Pensioenfonds ABP, Heerlen, the Netherlands, about working on its global strategy.
ABP recently implemented what Jan Straatman, head of equities, calls "a truly global approach" in its equity investments. "We have developed alpha strategies that have a very specific investment focus and a global investment horizon," said Mr. Straatman.
The e150 billion (US $138 billion) fund has e55 billion in equities, e28 billion of which is managed in-house.
ABP's in-house global equity investments are divided into three areas - global quantitative investing; a sector allocation portfolio, which takes only long-term sector allocation bets; and a global bottom-up investment process, which is sector-neutral and has a longer-term investment horizon.
"We combine those internal strategies with a variety of external managers which have focused alpha strategies that are opportunity-driven," said Mr. Straatman.
The external managers focus on certain investment styles, such as small-cap or global value, or specific regions such as emerging markets.
Mr. Straatman said he prefers to use external managers for specialized mandates because "there are only a limited number of truly global equity managers."
The fund uses a customized Morgan Stanley Capital International global benchmark for the entire equities portfolio that is 50% European stocks, 40% North American stocks and 10% in the rest of the world including emerging markets. Mr. Straatman said it's basically "an ACWI (All Country World index) with a larger focus on Europe because that's our home market."
Mr. Straatman said the results of the portfolios "have been promising" so far. He declined to detail performance, saying the funds have not been running for a long enough time.
Mandates from clients
Arrowstreet Capital LP, Cambridge, Mass., has active global mandates from two clients - a European pension fund that has $300 million in a global mandate and a Canadian pension fund that invested C$500 million (US$313 million) in its global strategy.
"It is a country, sector, basket approach," said Peter Rathjens, managing partner and chief investment officer of Arrowstreet.
"We look for countries, sectors and companies that we would like to overweight and underweight," he added. "One of the implications of global integration is that sectors are correlated."
Mr. Rathjens said an investor could be exposed to more "hidden portfolio risk" using separate U.S., international and emerging markets money managers. "The U.S. manager could be overweight (in) tech stocks and the emerging markets manager could also be overweight (in) tech stocks. And because it's uncoordinated, total risk exposure is greater than anyone realizes," he said.
Global mandates can be used for passive portfolios as well.
Alan Brown, global chief investment officer for State Street Global Advisors, Boston, believes that instead of using index funds, which tightly mimic the index against which they are benchmarked, investors should go "truly passive" and "own the world."
"Passive management is supposed to be all about owning the world market portfolio in (float-adjusted) capitalization weights," said Mr. Brown. "It says nothing about making arbitrary distinctions between, say, domestic and international equities, developed and emerging or growth and value.
"All of these categorizations are implicitly suggesting that prices are not at equilibrium; they are in effect either inefficient expressions of an active view, or expressions of `prejudice' in favor of, say, domestic assets," he added.
"We have the empirical evidence that active managers find it difficult to outperform benchmarks and we have the certainty that true passive management saves a lot in costs - both management fees and also turnover-related expenses."
Mr. Brown said the idea for this style of passive management came from one of the firm's clients, a U.S.-based multinational company for which SSgA set up such a portfolio for its pension fund.