Pension fund executives around the world are putting their faith — and assets — into emerging markets to provide more investment bang for the buck.
But some consultants and money managers believe pension funds still have a long way to go and need to increase those allocations closer to 35% of total assets — or roughly the weighting of emerging markets in the global economy — from the current allocation of about 5% or less for the average fund.
“Where pension funds are (invested in emerging markets), relative to where they should be, is a massive underweight position,” said Jerome Booth, London-based head of research and a member of the investment committee at Ashmore Investment Management Ltd. “This reality has been true for a while, but the credit crunch has made it much more obvious.”
The financial crisis has challenged several historical assumptions generally made about investments in developing nations, including the level of volatility, liquidity constraints and ability to withstand a severe global downturn. So far, emerging markets generally have fared better than major economies in weathering the storm, helping to attract assets at a record pace.
“We're in the midst of resetting the clock on emerging markets. Going into this (financial) crisis, the assumption that many pension plans — even the most sophisticated — made was that emerging markets would do less well than developed countries coming out of it,” said Cynthia Steer, chief research strategist and head of beta research group at consulting firm Rogerscasey Inc., Darien, Conn.
“A whole new construct is evolving — driven by factors such as higher (gross domestic product) growth and lower impact from the banking crisis on emerging markets. This is a presage to a re-evaluation of the risk/return relationship between developing and developed markets” by defined benefit pension fund executives, Ms. Steer said. “I think it is long overdue.”
The Morgan Stanley Capital International Emerging Markets index climbed 7.2% in the year since Lehman Brothers Holdings Inc. declared bankruptcy on Sept. 15, 2008. In comparison, the Russell 3000 index was down 11.7% and the MSCI World index, which tracks stocks in developed markets, returned -9.6% during the same period.
Emerging markets now account for about 12% of the MSCI All Country World index, which tracks companies in both developed and developing countries, compared with 5% at the beginning of this decade. However, the average exposure for pension funds investing in emerging market equity is between 3% and 8% of the total equity portfolio, and the average range for the emerging market fixed-income allocation is from 2% to 5%, according to estimates from consultants. Alternative investments in emerging markets probably total less than 2% of the total portfolio even for the most sophisticated pension funds, they said. Depending on individual funds' risk/ return targets, many should be doubling those exposures within the next five years, consultants said.