As institutional investors ratchet up their allocations to emerging markets, they're looking beyond equities to portfolios designed to allocate risk across different asset classes within developing economies.
Public equity remains the dominant route to gaining exposure to emerging markets, according to consultants, managers and fund executives. However, institutional investors are now beginning to focus on building more balanced emerging markets portfolios that also include emerging markets debt, currency and other alternative investments. Even within the equities strategy, investors are emphasizing diversification rather than eye-popping returns.
“Investors in emerging markets should, and are increasingly, seeking to understand, manage and decompose the risk factors in their portfolios,” said George Hoguet, managing director, senior emerging markets portfolio manager and global investment strategist at State Street Global Advisors based in Boston.
At the $41 billion Juneau-based Alaska Permanent Fund Corp., executives recently appointed Capital Guardian Trust and are in the final stages of reviewing Pacific Investment Management Co. LLC with the idea to split an $820 million multiasset emerging markets portfolio. Under the new multiasset mandate, managers have discretion across risk factors and asset classes to invest not only in equities but also emerging markets debt, currency and other alternative public emerging market securities, said Jeffrey Scott, the fund's chief investment officer.
“It's safe to say that, based on emerging markets' share of the global (gross domestic product), most public institutions have a tremendous (home country) bias,” said Mr. Scott. “Emerging market countries are contributing north of 40% of global GDP, yet most public institutions are invested primarily in the developed markets.”
“However, it doesn't mean that emerging markets will give you better risk-adjusted returns. You still have to do your homework and assess the current valuations,” Mr. Scott said in a telephone interview. “Do we believe in the emerging markets story in the long term? Yes. ... We anticipate greater weight to emerging markets and increased diversification across risk premia relative to the existing portfolio composition.”
Alaska Permanent currently has a 7% allocation to all emerging markets strategies.
Among U.S. pension funds, the average allocation to emerging markets equities and debt is about 4.5% and 1.7%, respectively, as of Sept. 30, 2010, according to a Pensions & Investments analysis from data provided by plan sponsors. While this is an increase from the 3% exposure to emerging markets equities and 1% to emerging markets debt three years earlier, the allocation is still small relative to the economic growth potential of those economies, sources said.
Emerging markets account for 13.8% of the MSCI All Country World index, a cap-weighted index comprising developed and developing market stocks.
“On average, U.S. DB pension funds are about 50% underweight in emerging markets relative to the typical cap-weighted (global equities) benchmark,” said Kathryn Koch, London-based senior portfolio strategist and chief of staff for Jim O'Neill, chairman of Goldman Sachs Asset Management.
Emerging markets debt, which is increasingly sought by investors as an investment diversifier, accounts for about 3% of the J.P. Morgan Global Aggregate index. Frontier market equities still account for a relatively modest portion, or less than 1%, of the $23 trillion world market capitalization. The majority of institutional investors do not have a dedicated frontier markets strategy, but some may have exposure to the asset class through broad global emerging markets mandates.
“Frontier markets do exhibit lower correlation to the broader emerging markets,” said Jose Gerardo Morales, CIO for Mirae Asset Global Investments (USA) LLC. Mirae has about $53 billion in assets under management globally, about $30 billion of which is invested in emerging and frontier markets.