Money managers are adding more arrows to their emerging markets quiver as they anticipate institutional investor demand for such strategies to escalate over time.
“My sense is that there are adequate products for the interest you have today, but that will change in the midterm period (of about five years) in which you'll have enhanced demand,” said Paul Matson, executive director of the $23 billion Arizona State Retirement System, Phoenix. “Furthermore, as emerging markets improve their domestic infrastructures, there will be more opportunities from the supply side and as a result, more products available.”
Consultants expect more pension funds to allocate to dedicated emerging market strategies within the next five years.
“The magnitude of those allocations” will also increase, said Terry Dennison, worldwide partner and U.S. director of consulting at Mercer Investment Consulting based in Los Angeles. “Instead of the current 5% range, (institutional investors) will probably be looking at 10% to 15% of total assets. And it will be strategic rather than tactical.”
Other consultants and managers said that longer term, developing nations might account for as much as 35% or more of the entire portfolio.
Managers that have been dedicating more resources to emerging market teams and products to capture this potential include: Pacific Investment Management Co. LLC; J.P. Morgan Asset Management; T. Rowe Price Group Inc.; Goldman Sachs Asset Management; Aberdeen Asset Management LLC; and The Boston Co. Asset Management LLC.
Others, such as emerging market specialists Franklin Templeton Investments and Ashmore Investment Management Ltd., also are reaping the benefits of increased investor interest. The firms reported $12.2 billion and $3.6 billion in net asset inflows, respectively, for the quarter ended Sept. 30.
“Institutional investors are gradually increasing allocations to emerging markets or thinking about (adding exposure) as part of a broader portfolio restructuring,” said Mark Mobius, executive chairman of Franklin Templeton, San Mateo, Calif., which manages about $30 billion in dedicated active emerging market strategies.
Consultants said institutional investors are likely to access the returns potential of emerging markets growth through relatively liquid asset classes such as equities, fixed income and currency — the areas on which most managers are also likely to focus.
So far, pension fund executives have been putting bigger bets on the equity markets than emerging market fixed income, but consultants expect to see more demand for the latter in the next several years.
Craig Mercer, senior investment consultant within the global manager research team at Watson Wyatt Worldwide based in London, said the case for emerging market debt is based on long-term improvements in economic fundamentals in these countries, leading to higher credit quality, lower cost of borrowing and more liquidity. An exposure to local currency debt allows investors to benefit from any appreciation of emerging market currencies relative to G7 currencies, he said.