David Smart, global head of sovereign funds and supranationals at Franklin Templeton, London, said recent wins from Asia's pension funds have targeted both active global and regional equities. He declined to comment on specific clients because of company policy, but said the mandates have generally doubled in size compared with the average range of $100 million to $200 million three years ago. The firm also has added new assets from existing clients, in some cases managing three or four different strategies following the initial mandate.
“If you're in situ as an existing manager doing a reasonably good job, you have significant advantages (to win additional mandates) relative to new managers,” said Mr. Smart, whose firm reported $670.7 billion in worldwide assets under management globally as of Dec. 31.
While Mr. Smart believes Asia's pension funds will continue to diversify globally, their liabilities are in local currency — a reality that will limit how much overseas exposure they should have. Mr. Smart estimates that many of the pension funds will probably maintain at least 35% and 50% of the total assets invested in local currency terms, depending on their risk/return profiles.
In China, more than 90% of the social security fund's total assets are invested domestically, mostly exposed to fixed income, equities and private equity. Overseas investments only account for about 7%, although fund officials have said they want to raise that figure to about 20% over time. The fund is expected to grow to $300 billion by 2015, with a potential increase of about $50 billion in overseas investments.
The NSSF has requested permission from China's Ministry of Finance and the Ministry of Human Resources and Social Security to invest in global alternatives, sources familiar with the matter said. Mandates are expected to be issued later this year — most likely in private equity — but government approval could face delays, according to sources who asked not to be identified.
While investments in the U.S. and Europe are on the fund's radar, initial investments could include Asian emerging markets such as Taiwan, sources said. (Restrictions to Chinese investments in Taiwan are likely to be lifted later this year.) Fund officials are also considering investing in hedge funds, infrastructure and real estate.
The NSSF's overseas investment strategy is “not an easy goal,” said Michael McCormack, executive director at Z-Ben Advisors, a Shanghai -based consulting firm. “One of the main questions that's being asked is whether or not the fund is on track to maximize returns over the long term. ... It is the investor of last resort for China's pension system.”
At year-end 2009, the latest data available, domestic fixed income accounted for about 41% of total assets, while 26% was allocated to domestic equities. Private equity investments in China totaled another 20.5%, and the remainder was split evenly between cash and overseas listed equities. Over the past 10 years, the fund has returned an average of 9.8% annually.
“There's a gap between what the fund has done (in the domestic market) and the need to diversify (globally),” Mr. McCormack added. “The fund is primarily invested in China, a market which has good depth but is pretty narrow.”
The fund's investment philosophy emphasizes capital preservation, Mr. McCormack said. “The only thing worse than not making money is losing money. What that means is that even though the fund needs greater exposure to overseas assets, how they'll get there will be incrementally. We're looking at regular and steady progress rather than dramatic movements.”
One major challenge toward a more global investment portfolio is that NSSF fund executives don't yet have a clear understanding about the fund's liabilities in relation to the country's pension system, making it more difficult to devise a effective portfolio diversification strategy, said Stuart Leckie, chairman of Stirling Finance Ltd., a research and consulting firm based in Hong Kong. “It's nonsense to decide whether your assets are diversified until you know something about the liabilities,” Mr. Leckie added.
A key constraint for both funds will be capacity, if only because of their size, sources said. Another major barrier is ensuring adequate internal resources to analyze opportunities in a timely manner, said Garry Hawker, regional director for national funds at Mercer LLC based in Singapore. “The challenge is being able to make a quick decision,” he added.
Funds based in some emerging markets also face an appreciation of the local currency compared with the U.S. dollar and the euro. When converted back to the local currency, foreign exchange movements could take a big bite out of any potential returns from developed market investments, sources said. For example, in 2010 the U.S. dollar fell 3.5% against the renminbi and 8.3% against the won, while the euro fell 10% against the renminbi and 14.3% against the won during the same period.
“A lot of funds are looking to hedge their (overseas) currency exposures,” Mr. Hawker said. “This is not necessarily straightforward. There's not a lot of capacity to hedge large amounts” for some emerging markets currencies.
Mr. Hawker expects other national pension funds and sovereign funds in Asia to continue increasing their allocations to equities and alternatives, as well as moving a larger portion of their investment portfolios overseas. Allocations to alternatives vary widely among funds, but the average Asian pension fund or other state-owned investment vehicle may be targeting an increase of a few percentage points within the next several years, Mr. Hawker said.