In an effort to gaining exposure to emerging markets equities, the Retirement Systems of Alabama, Montgomery, has found that investing in exchange-traded funds is the best approach.
The pension fund had about $1.2 billion of its $48.7 billion in assets invested in ETFs as of Sept. 30, marking one of the largest such allocations to ETFs among pension funds of its size, according to Pensions & Investments' annual survey of the largest U.S. retirement plans.
Marc Green, chief investment officer at the pension fund, said the ETFs serve primarily as a cost-efficient and liquid way to gain beta exposure to emerging markets equity. Indeed, ETFs in the portfolio include iShares MSCI Emerging Markets (EEM); iShares Core MSCI Emerging Markets (IEMG); and DFA Dimensional Emerging Core Equity Market (DFAE).
Green said the pension fund’s total emerging market ETF exposure is currently about $1.2 billion, and ETFs overall now total about $1.4 billion.
Stocks in emerging markets are especially attractive, Green noted, as the run-up of prices in the U.S. and other developed markets have rendered those equities fully valued or overvalued.
“Emerging markets equities are still compelling investments and have a significant valuation discount relative to North American equities” Green said. As of Dec. 31, the MSCI Emerging Markets Index traded at a forward price-earnings ratio of only 11.9, far below the comparable figure of 19.1 for the MSCI World index, and also below the 13.9 ratio for the MSCI World-ex U.S. index.
For the one-year period through Sept. 30, MSCI Emerging Markets index returned 26.1%, outpacing the MSCI World ex U.S. index, which returned 25%.
Exposure to emerging markets equities also provides the pension fund with good diversification, Green noted.
The retirement systems' assets are almost entirely internally managed, and with a relatively small internal investment staff of about 15 people, it would be too costly for investment specialists to research potential emerging markets investments in person, Green said.
Alabama also has stakes in other ETFs across some broad sectors. According to a recent 13F-HR filing, as of Sept. 30, the pension fund also owned SPDR S&P 500 (SPY); SPDR S&P Midcap 400 (MDY); Vanguard S&P 500 (VOO); Vanguard Small Cap Value (VBR); iShares MSCI EAFE ETF (EFA); iShares Core S&P Small-Cap ETF (IJR); and iShares Core S&P 500 (IVV).
Fixed income
For exposure to fixed-income markets, the pension fund has invested in iShares 1-3 Year Treasury Bond (SHY); iShares 7-10 Year Treasury Bond (IEF), iShares Core U.S. Aggregate Bond ETF (AGG), Vanguard Short-Term Corporate Bond Index (VCSH) and Vanguard Total Bond Market Index Fund ETF (BND).
Fixed-income ETFs, Green indicated, proved their mettle during the historic sell-off in the spring of 2020 in the wake of the COVID-19 outbreak. Amidst huge market volatility and declining liquidity, fixed-income ETFs continued to trade efficiently and provided some measure of stability to a battered market.
ETFs are not only transparent and highly affordable (with expense ratios as low as 0.07% in some cases) but they also provided excellent liquidity, are easily and quickly tradable and allow exposure to a wide range of asset classes, sectors and regions, allowing a portfolio to have greater diversification, he noted.
However, Green indicated that the pension fund currently owns no actively managed ETFs, nor do they have any plans to significantly increase their exposure to ETFs anytime soon.
Overall, the pension fund has a relatively low allocation to alternative assets. As of Sept. 30, the fund had almost 87% of its assets allocated to traditional asset classes — nearly 63% in equity, 15.5% in fixed income and 8.2% in cash. Green explained that this is linked to the high fee structures typically associated with investing in private and alternative assets. And given how the performance of private assets has lagged public markets, it didn’t make much sense to add to alternatives, he added.
Green said he does not have the sole authority to invest on behalf of the pension fund. Rather, the investment staff and investment committees make investments in accordance with the investment policies established by the respective boards of control of RSA.
As or Sept. 30, 2024, RSA comprised three defined benefit plans — the $31.9 billion the Teachers’ Retirement System, the $16.5 billion Employees’ Retirement System, and the $372 million Judicial Retirement Fund — and they also administer several other smaller funds as well.
For the fiscal year ended Sept. 30, TRS, ERS and JRS posted annual returns of 21.1%, 21.2% and 22.2%, respectively.
Tom Bailey, London-based head of research at HANetf, a European ETF issuer, said that ETFs are increasingly becoming a “go-to tool” for pension funds due to their transparency, cost-efficiency and liquidity.
“For institutions managing large and complex portfolios, the ability to trade throughout the day and make precise allocation adjustments is invaluable,” Bailey said. “ETFs offer straightforward access to a wide range of exposures, so we expect to see pension use increase further.”
Bailey further indicated that his firm has seen “significant interest” from pension funds in Austria and Germany, with these institutions recognizing the practical advantages of ETFs in meeting their investment objectives. HANetf has about $5 billion in AUM.
Regarding whether other pension funds will move more into ETFs, Green said: “I am uncertain on that, but on short-term reallocations I think they are used quite extensively.”
