Election risk combined with the ongoing coronavirus pandemic is leading some European asset owners to pull back on developed market equity exposure.
Some European pension fund executives are increasing the share of emerging market equities at the expense of developed markets, with a view that the dollar will remain weak in the coming quarters and therefore benefit developing economies, while others are upping exposures to small, unlisted companies.
At the height of the COVID-19 pandemic, many European investors reduced exposures to developed market equity investments, according to flow data by eVestment LLC, Marietta, Ga. European equity strategies saw outflows of $6.9 billion in the first quarter of the year and $9.1 billion in the second quarter. European investors moved away from U.S. equities, overall reducing exposure by $5.4 billion in the first quarter and $4.3 billion in the second quarter.
Following a period of market stability in the third quarter, pension fund executives are now considering what portfolios should look like as they move into the fourth quarter.
"Volatility in equity markets has been trading higher. The main reason for that is the U.S. election. We are expecting to see (even) higher volatility," said Mikko Mursula, CIO of the €49 billion ($57.4 billion) Ilmarinen Mutual Pension Insurance Co., Helsinki. "It is important who will gain control over the Congress. There is a chance that the election result will be challenged, which could prolong the period of uncertainty," he added.
On the back of that uncertainty, some pension executives are recalibrating portfolios. Mikael Angberg, CIO of the 355 billion Swedish kroner ($39.7 billion) AP1, Stockholm, Sweden, said the fund has been increasing exposure to equities in the third quarter, moving to just short of 60% from about 45% at the height of the pandemic. Mr. Angberg said the fund has been adding emerging markets and European small-cap equities to help weather the volatility in developed market equities that he expects could follow the U.S. elections, regardless of whether Donald Trump or Joseph Biden wins.
Luc Vanbriel, CIO of the €2.4 billion defined benefit Pensioenfonds KBC, Brussels, is taking similar steps. Mr. Vanbriel said that the fund's exposure to the MSCI European Economic and Monetary Union index was half of the total 34.5% of equity allocation. This exposure is being moved to the MSCI ACWI, which was the other half, as executives are targeting a 10% allocation to eurozone countries and a 12% exposure to emerging markets.
"We have done an analysis of drawdowns and volatility of monthly returns. The past return would have been better if we skipped the home bias, but that's not guaranteed for the future. The volatility on the other hand is less if you leave your home bias. It took the broader benchmark less time to recover from drawdowns," he said.
"We are concerned about the valuation of (the) North American equity market from now until the end of 2021," he said. "That's why we are obviously very careful during the transition," he added.
Fonds de Reserve pour les Retraites, Paris, is also gradually selling developed market equities. Olivier Rousseau, executive director at the €25 billion fund said its executives recently slated €750 million for private equity investments, which will be invested in private equity of small unlisted French companies.
The fund's new private equity program consists of €500 million of investments in French companies and €250 million of investments in the technology sector in France.
The recently approved new allocation, he said, will be gradually funded from developed market equity investments when the fund receives capital calls from its managers. "As and when we receive a capital call, we finance it by reducing investments in listed equity. We have a bit of cash, but we do the rebalancing of (private) equity exposure from listed equities," he said.
Mr. Rousseau added the fund has a "reasonable" exposure to emerging market equities at 4%. "We believe the dollar will be soft not strong in the near future. The investment conclusion could be to be tempted to invest in emerging markets," he said.
