More U.S. institutional investors are ditching the home-country bias that has kept the bulk of their equity allocations in domestic stocks.
With non-U.S. stocks now comprising 55% of global stock-market capitalization, a shift to a global benchmark promises to move assets to foreign equity markets, while accelerating outflows from U.S. equities.
Data from Casey Quirk & Associates LLC, a Darien, Conn.-based consultant to the money management industry, showed net institutional outflows of more than $100 billion from U.S. stocks for the 12-month period ended June 30. The latest data being crunched now show that trend accelerating, said Philip Kim, a senior associate with the firm.
Rodger F. Smith, a managing director with Greenwich, Conn.-based Greenwich Associates, said the portion of U.S. institutional equity holdings in non-U.S. equities could grow to almost 30% by the end of this year from 25% in 2006.
Adding fuel to the fire is the growing list of large pension funds joining heavyweights such as the $71.4 billion Washington State Investment Board, Olympia, and the $54.2 billion Massachusetts Pension Reserves Investment Management board, Boston, which already have equal allocations to domestic and foreign equities.
One of the latest funds to move is the $13 billion health-care fund of the Ohio Public Employees Retirement System, Columbus. In October, that fund’s board voted to shift its 2-to-1 mix of U.S. and non-U.S. equities to a 50-50 split starting next month.
Jennifer C. Hom, OPERS’ chief investment officer, said the decision was based on the need to gain greater exposure to the global markets, including companies in the fast-growing emerging markets. She said a similar shift is likely for OPERS’ $70 billion pension fund when its asset allocation comes up for review in 2009.
The board of $259.5 billion California Public Employees’ Retirement System, Sacramento, is scheduled to meet Dec. 17 to consider a staff recommendation to shift the plan’s target equity benchmark to a global market weighting (roughly 45% U.S. to 55% non-U.S.) from its current 66.7% U.S. and 33.3% non-U.S. split.
In supporting documents, CalPERS staff said growing cross-country trade and capital flows, the convergence of accounting and reporting standards around the world, and falling costs of investing internationally have undercut previous arguments in support of home-country bias. The move also would improve the efficiency of passive mandates, while giving active managers added scope to deliver alpha, those documents said.
Backing the home front
Arguments for maintaining some home bias can still be made. Carl Hess, Americas practice director for New York-based Watson Wyatt Worldwide’s investment consulting practice, said that with domestic equities serving as a better hedge against dollar-based liabilities, some U.S. clients will continue to prefer allocating something closer to a third of their equity holdings to international. Others contend the hefty portion of U.S. multinationals’ revenues coming from overseas operations means investors who maintain that bias are still profiting from global growth.
But Cynthia F. Steer, managing director and chief research strategist with RogersCasey Inc., Darien, Conn., said there’s a growing recognition “that having a tremendous home-country bias in equity, let alone fixed income, is not appropriate any more.”
Investment consultants, while they’ve long urged clients to consider global equity as the starting point for asset allocation decisions, say they had accepted that pension executives’ relative comfort with domestic markets would limit overseas investments.
In recent years, however, those limits have receded. “A tremendous opening of the mind to investing overseas” in the past decade has seen many clients lifting the non-U.S. portion of their equity portfolios to roughly 33% today, from between 10% and 15%, and the next step many will consider is whether to abandon home-country bias altogether, said Jay Kloepfer, senior vice president and director of the capital market research group at Callan Associates Inc., San Francisco.
Some consultants have become more aggressive in urging clients to go global.
Richard Nuzum, Americas business leader for Mercer LLC’s investment consulting practice in New York, said Mercer has been advocating a 50-50 split between domestic and international equities since early 2006.
Starting point
Michael D. Sebastian, a principal with Chicago-based consultant Ennis Knupp & Associates, said his firm’s call for a 50-50 mix at its latest annual client meeting in October will be the starting point for asset allocation discussions with clients.
Judith M. Johnson, executive director and chief investment officer of the $1.4 billion Minneapolis Employees Retirement Fund, an Ennis Knupp client, said over the coming year she’ll be open to exploring an asset allocation mix that reduces or eliminates home-country bias. Three years ago, Minneapolis officials adopted an asset mix that included 40% domestic equities, 20% in international equities and another 10% in global equities.
Some observers worry the spectacular gains posted by non-U.S. stocks — particularly in emerging markets — in the past five years could be clouding the debate.
An eight-page document presented on Oct. 15 to CalPERS’ investment committee shows the pension fund would have enjoyed cumulative returns of 142.1% for the five years ended June 30 if it had followed a global equity benchmark, better than the 117.8% gain it achieved with its current mix.
Mr. Nuzum concedes the resolve of Mercer clients who have abandoned home country bias in recent years hasn’t been tested by a period of U.S. outperformance, like that of the late 1990s. Mercer executives need to ensure clients moving today aren’t “vulnerable to regret risk” should, for example, the dollar rally sharply in the near term, he said.
As more pension plans move to drop home-country bias, they’ll face the additional question of whether to adopt a global benchmark as well — a move that could lead to greater transition costs by forcing clients to switch domestic and international specialist mandates to broader global mandates where “the world is your oyster,” Mr. Kloepfer said.
The emphasis on where companies are domiciled will inevitably shift to where they get their revenues, but for now maintaining existing asset allocation frameworks and simply shifting domestic and non-U.S. holdings toward a 50-50 balance will allow clients to enjoy the bulk of the benefits with the least disruption, said Mr. Sebastian.
Robert Maynard, CIO of the $12 billion Public Employees Retirement System of Idaho, Boise, welcomes the trend toward adopting more global equity mandates, which will inevitably lead to the development of better tools and diagnostics to track performance. For now, Idaho has developed its own system to track its allocations of roughly 25% of the total portfolio to domestic stocks, 23% to global equities and 15% to non-U.S. stocks.
An added benefit will be an increase in the number of money managers with the resources to handle global mandates, beyond the 15 or 20 truly capable of doing so today, Mr. Maynard said.
