Uncle Sam looks better to overseas investors

Institutional investors in Europe and the Middle East may be poised to raise their stakes in the U.S.

Low valuations and aggressive federal intervention to lift the economy out of recession are enticing overseas investors, according to consultants and asset managers. Although most investors are still on the sidelines because of high volatility in markets globally, there's evidence that an increasing number are laying the groundwork to buy more U.S. assets in 2009, including listed stocks, corporate bonds, private equity and real estate.

At a time when many U.S. active asset managers are struggling to attract new business amid the market turmoil, renewed interest in U.S. investments among overseas institutions may be an important key for their long-term growth, according to consultants and managers.

Diversification is another key driver, consultants said. Especially in Europe, where investors generally underweight U.S. stocks within their equity portfolios, some are planning to add U.S. equity or switch to a global strategy, which generally has a larger portion invested in the U.S.

“As investors diversify more overseas, the U.S. has been increasing as a function of that trend,” said Mary Kerrigan, senior investment consultant at Watson Wyatt Worldwide, Reigate, England. “I would expect that trend to continue.”

One investor looking for more opportunities in the U.S. is the Dubai Group, a government-owned asset management company set up as part of Sheikh Mohammed Bin Rashid Al-Maktoum's plan to diversify Dubai's economy. The company does not disclose assets under management, but estimates from banking analysts have the Dubai Group at around $40 billion.

Earlier this year, the Dubai Group added a second U.S. office in Pittsburgh to focus on U.S. capital markets. The group is aiming to raise $500 million to $1 billion from investors in the Middle East and North Africa to invest in a fund focused on U.S. equity. Direct stakes in U.S. real estate and asset management companies are being considered, according to Soud Ba'Alawy, executive chairman of the Dubai Group, Dubai, United Arab Emirates.

“We've got a strong balance sheet and strong liquidity,” Mr. Ba'Alawy said in an interview at the World Pension Forum conference in Dubai in November. “We're quick to make sure that we're positioning ourselves to take advantage of the opportunities for the next cycle to come.”

Other investors, such as the Abu Dhabi Investment Authority, the world's largest sovereign wealth fund, might add U.S. private equity investments, according to a source familiar with the fund. Based in Abu Dhabi, United Arab Emirates, ADIA doesn't reveal assets under management, but recent estimates by banking analysts have been around $675 billion. About 5% of its portfolio is invested in private equity.

“Any area showing signs of distress is a good place for investors to set their sights,” according to the source. “This does not mean that (ADIA) will forget about Asia or the Middle East or Europe; a well-diversified portfolio means being interested in all regions globally. But at the moment, valuations in the U.S. indicate that there are probably some good companies that can be acquired relatively cheaply.”

In Europe, a long-term structural shift away from a regional or domestic bias is combined with a short-term cyclical trend toward the U.S. as a relatively safer market during a global downturn, said Lucy MacDonald, director and CIO of global equities at RCM (UK) Ltd., London. A stronger dollar and general outperformance of U.S. equity compared to international equity strategies this year have also bolstered the case for investors to consider buying American.

“The U.S., as a market, is a more diversified and deeper market,” said Ms. MacDonald, whose firm has $105 billion in assets under management, $10.6 billion of which is in U.S. equity strategies. “In a difficult investment environment where risk aversion is high, that's where people tend to want to hide in equity terms.”

The structural shift toward global equities is particularly evident in the U.K., where the average allocation to domestic stocks stood at about 50% of the overall equity strategy among pension funds, said Watson Wyatt's Ms. Kerrigan, citing data from Bank of New York Mellon Corp., New York. In comparison, U.S. equity averages about 12% of the total equity allocation. Five years ago, U.K. equity comprised about 70% of the typical equity portfolio.

Ms. Kerrigan estimates that domestic equity exposures among U.K. pension funds might shrink to 10% to 20% as a percentage of the entire equity portfolio in five to 10 years. Depending on market capitalization movements, the U.S. equity could increase to 30% to 50% within the same time frame. By market capitalization as a percentage of the global economy, the U.S. accounts for 50.28% while the U.K. accounts for 9.76%, according to a breakdown by country of the Morgan Stanley Capital International World index as of Sept. 30.

Another factor attracting investors is the theory that U.S., having led the world into a recession, would be the first to lead global markets out of the economic quagmire, according to Peter Preisler, Copenhagen, Denmark-based director and head of business development for Europe, Middle East and Africa at T. Rowe Price Group Inc. T. Rowe Price had $345 billion in assets under management as of Sept. 30.

“We're seeing more activity in U.S. strategies (coming from EMEA clients) now than we've ever seen in 2½ years,” said Mr. Preisler, who declined to name specific clients. “Investors are looking at investment-grade bond, high-yield and equity in the U.S. market. ... We see a lot of potential business.”

Ulrika Bergman, head of institutional sales for Benelux and Scandinavia at Principal Global Investors, Des Moines, Iowa, also has noticed an increase in institutional interest in U.S. equity. Principal is participating in two separate searches worth several hundred million euros each from European pension funds for active U.S. equity managers. Ms. Bergman declined to name the funds.

“A year ago, there was no interest in U.S. equity” from European institutional investors, said Ms. Bergman, whose company reported $228 billion in total worldwide assets under management as of Sept. 30, including about $19 billion in U.S. equity strategies. “Many have actually been taking down their exposures (to U.S. equity) up until the end of last year. Now, they seem to be looking at opportunities to get into the U.S. again, not only because the dollar is strengthening, but U.S. stocks look cheap. ... Of course, they may get even cheaper, so I don't think (investors) are going to rush into it.”

Asset managers running global equity strategies are already shifting a bigger chunk to U.S. equity, according to Michael Green, London-based senior vice president for international at American Century Investments Services Inc. For example, in the firm's own global growth strategy, 54% of the total assets were invested in the U.S. at the end of October. A year ago, that number was about 40%, he said. The strategy has about $3 billion in assets.

“It hasn't been a conscious decision to expand the U.S. portion” of the global portfolio, Mr. Green added. “It is entirely a function of where we have found the opportunities from a bottom-up perspective.”