International returns deliver nice bonus to funds

Emerging markets equities sizzled in 2003, returning a whopping 46%, giving the pension funds that invested in them an enormous boost to their overall portfolios.

Indeed, it was not a bad year to be in foreign equities in general, with the Morgan Stanley Capital International Europe Australasia Far East index gaining a hefty 26.5% over the 12-month period ended Sept. 30. That topped domestic stocks, as the Russell 3000 returned 25.9%.

Collectively, the defined benefit plans among the 200 largest U.S. employee benefit plans reported $316 billion in active international investments as of Sept. 30, up 23.5% from $255.8 billion on an unadjusted basis from Sept. 30, 2002. Adjusted for the market surge, however, the growth was less than 1%. The top 200 plans had $283.6 billion in active international equities as of Sept. 30, up 30% overall from $218.8 billion as of Sept. 30, 2002, but up just 2.5% on a market-adjusted basis. And the funds reported $32.4 billion in international active bonds — down 12.4% on an unadjusted basis, a drop of 15.6% adjusted for the market — from a year earlier. (The Citigroup World Government Bond index, non-U.S., returned 3.69% for the year ended Sept. 30.)

In emerging markets, the defined benefit plan sponsors had $45.1 billion invested, up 48% on an unadjusted basis but only 2.2% on an adjusted basis, from the $30.4 billion reported as of Sept. 30, 2002.

They had $39.7 billion in emerging markets equity as of Sept. 30, up 55% unadjusted (6% adjusted), from $25.6 billion a year earlier. (The Morgan Stanley Capital International Emerging Markets Free index was up 46% for the same period.) And in emerging markets fixed income, the defined benefit plans reported a total of $5.4 billion as of Sept. 30, up 13% unadjusted, but down 19% when the 40.19% return of the J.P. Morgan Emerging Markets Bond Index Plus is taken into account.

Although many pension funds saw the size of their emerging market portfolios jump more than 50%, thanks to the strong markets, some gained even more because of an increased allocation. That was the case at the $32 billion Massachusetts Pension Reserves Investment Management Board, Boston, which in September increased its allocation by $625 million, raising it to 5% of total assets from 3%, said Stan Mavromates, deputy chief investment officer. At the same time, MassPRIM reduced its allocation to developed markets international equity to 15% from 17%, keeping the total international equity allocation at 20% of assets.

"The changes were the result of an asset allocation review that the board approved in June. The system's managers are particularly excited about Asia, where they believe they can find better valuations than they can in the U.S.," said Mr. Mavromates.

MassPRIM reported $5.1 billion in active international portfolios, all equity, and $1.5 billion in emerging market investments, also all in equity, as of Sept. 30. A year earlier, the fund reported $3.56 billion and $828 million, respectively.

Emerging market assets also jumped 60% at the $7.5 billion Public Employee Retirement System of Idaho, Boise, said Robert Maynard, chief investment officer. He credited the gain to the strong markets. "We had a spectacular year overall; our best calendar year ever," he declared proudly. "The pension fund was up 25.6% for the year (calendar 2003), and a lot of that was due to emerging markets equities."

The Idaho system has 3.5% of total assets allocated to emerging markets equities, but some of its global managers also invest in emerging markets, so the actual investment is probably higher, Mr. Maynard noted. The global managers earned a 46% return on their investments while the international equity investments returned 40%, he said.

Idaho had $1.02 billion in active international securities, of which $781 million was in equities, as of Sept. 30, up from $816 million total ($589 million in equities) a year earlier. The fund also reported $217 million in emerging markets investments, all equity, as of Sept. 30, compared with $145 million a year earlier.

"We were overweight international collectively by the end of the (calendar) year and rebalanced, taking 2% from international equities and putting it in domestic equities, so that we now have 15% in international equities. But if you also count the amount global managers oversee, our total exposure to international equities is around 20% of assets," Mr. Maynard said.

Emerging markets also outperformed at the Public Employees Retirement System of Ohio, Columbus, returning 58.6%, said Farouki Majeed, deputy director of investments at the $58.7 billion system. That in turn helped the overall pension fund return 25.6% for calendar 2003. The total international equity portfolio also did extremely well, returning 40.7%, Mr. Majeed said. "We were overweight emerging markets, which contributed to our overall strong performance. Around 15% of our international portfolio was in emerging equities, or around 1.2% of the entire pension fund, and we plan to maintain that allocation," he said.

OPERS increased its foreign small-cap allocation to both developed and emerging markets to gain added exposure to companies with market capitalizations of less than $1 billion. "We particularly like Asia, excluding Japan; India and certain Latin American markets, especially Brazil, which did well for us," Mr. Majeed said.

OPERS had $6.6 billion in active international portfolios, all equity, and $1.16 billion in emerging markets ($676 million in equities) as of Sept. 30. That was up from $3.75 billion and $735 million ($436 million in equities) a year earlier.

At the $74 billion pension fund of General Motors Corp., Detroit, emerging equity markets rose 47%, in line with the MSCI Emerging Markets Free index.

"Market appreciation really helped," said Ben Gong, investment analyst in the emerging markets group at General Motors Asset Management, New York, which manages the GM pension fund. GMAM does not break out the size of its emerging markets allocation, which is part of the total international equity allocation; that was 19% of total assets as of Sept. 30.

Mainly, GMAM follows the MSCI EMF index, but it did make some marginal bets in emerging markets that turned out well, Mr. Gong noted.

"We invested more in India and Brazil. Those economies are improving and companies are turning around."

GM reported $12.9 billion in active international strategies, of which $10.3 billion was in equity, as of Sept. 30, up from $11.77 billion overall and $9.6 billion in equities a year earlier.

The $6.2 billion pension fund of American Airlines Inc., Fort Worth Texas, is rebalancing its international investments after achieving superior returns in emerging market equities.

Emerging market stocks were up 58%, while international equities rose 42% for the year, said William Quinn, president of AMR Investment Services, which manages American's pension assets.

"They boosted the whole plan, which returned 25% for the year. We are rebalancing back to our targets of 20% international and 5% emerging markets," he said. "We're reallocating some of that into underperforming assets, and may add to domestic stocks. We're just re-evaluating now, looking at adding to (global) bonds and maybe moving into real return assets."

American had $1.5 billion in active international strategies ($1.4 billion in equities) and $312 million in emerging markets ($202 million in equities) as of Sept. 30, compared with $1.15 billion in active international ($1 billion equities) and $247 million in emerging markets ($145 million in equities) a year earlier.

International equities did so well at the $10.2 billion Illinois State Board of Investment, Chicago, returning 35.9% in calendar 2003, that the allocation has been reduced to 10% from its target policy of 15% of total assets, said William Atwood, executive director. "It outpaced everything else in the portfolio and had grown to 16.5%" of total assets.

The money will be moved to domestic equities. "We're cutting back on international equities because long-term we're more comfortable investing domestically," Mr. Atwood explained.