Where in the world?

Alistair Wilson
Head of institutional business, Neptune Investment Management
Wilson joined Neptune in 2005 from Legal & General Investment Management where, from 2001, he was a business development manager in the corporate pensions department. During that time he was responsible for promoting LGIM’s funds to corporate pension schemes through a variety of investment consultants. Prior to this Wilson was a client account manager at LGIM.

Alison Hamilton
Investment director, global equities, Martin Currie Investment Management
Prior to joining Martin Currie in 1998, Hamilton spent six years with Standard Life Assurance, specialising in US equities and managing some £2bn in pension funds. She subsequently set up and ran SL’s Latin American team. At Martin Currie Hamilton worked in the emerging markets team, responsible for investments in Latin America, before being appointed to manage
high-alpha global equity products.

Stephen Holt
Head of UK institutional sales, Principal Global Investors
Holt qualified as an actuary while working at Hymans Robertson in Glasgow, and has held senior investment sales positions at Barclays Global Investors, Threadneedle and Santander. He joined Principal Global Investors in 2006 to spearhead the $200bn (£101bn) US asset manager’s entry into the UK institutional marketplace.


Research by Citigroup suggests pension funds are shifting away from UK equities in favour of taking greater overseas exposure (since 2000, British institutional investors have bought an average of £11bn of overseas equities each year while disposing of a similar amount in UK stocks). Do you expect this trend to slow or will new opportunities abroad continue to sustain a consistent growth in overseas investment?

Wilson: We certainly expect to see this trend continue. The traditional approach of running a systematic overweight in UK equities, due to the location of a scheme’s liabilities, is taking a reduced relevance. Even when investing in the UK, an investor has to take a largely global view, as the index is dominated by multinational companies or those operating in a global market. Furthermore, the UK investor must also accept inherent sector biases in the UK market.
The traditional pension fund approach, weighting UK versus overseas, is becoming less important. Fund manager expertise should not be limited by geographic parameters but rather be given the broadest opportunity to utilise their skill set. For this reason we believe that an unconstrained global mandate is the best approach. Inevitably this leads to a reduction in the UK weighting in most funds.
With its wealth of market leaders, the UK should certainly not be ignored, but, equally, it must be considered within the context of the global market.

Hamilton: While much of the shift has already taken place, the high number of new global equity mandates being awarded suggests there may be further to go. The case for a more international perspective is compelling: UK pension funds can reduce their overall risk profile and, in most cases, enhance investment returns. Investors can access the investment potential of some of the world’s most attractive companies. They can also mitigate the risks presented by a UK stock market that is heavily concentrated in a few very large stocks, and heavily represented in the banking, telecommunications, energy and pharmaceutical sectors.
Although UK pensions funds’ allocations to international equities should continue to grow, there will probably always be a degree of home country bias. There are several good reasons for this. Domestic equities offer greater familiarity, no additional currency risk and higher dividends. And the UK stock market also offers more of an exposure to the global economy than investors might expect, particularly through the largest stocks.

Holt: We see this trend continuing at a similar pace, and not only among UK pension schemes, but also among pension schemes in the US and elsewhere. The realisation that we all live, work and invest in a global market is now well established, and the lines between developed and developing markets are becoming increasingly blurred. Ignoring the breadth of global investment opportunity in favour of a pronounced bias to a concentrated and relatively defensive local market is increasingly hard to justify.
UK pension funds have long had a dominant local market bias in their equity allocations. While a degree of local bias is both understandable and justifiable, our concerns would focus on the magnitude of this bias, despite the moves to greater international investment in the last decade. There is little economic rationale for the magnitude of home country biases by most UK pension funds, and liquid currency and equity markets allow easy hedging of currency risk and swift asset allocation changes if required.
Despite the trend to greater overseas equity allocations, the typical UK fund will have a domestic equity weighting that is multiple times that of the UK market in global market cap weighted benchmarks and also multiple times that of the UK’s overall contribution to global GDP.
In addition, one could argue that defining ‘domestic’ equities, according to the stock market where a stock has its primary quote, is increasingly arbitrary and difficult to justify given the global activities of mega cap stocks. Simply put, the mailing address of a company’s chief executive is not the best criteria for determining optimal asset allocation and ‘domestic’ versus ‘overseas’ weightings.

Considering the current US economic climate, should pension funds be reducing their US exposure in favour of other global markets?

Wilson: As with the UK, the US gives a wide range of investment opportunities, some of which will have exposure to the domestic market but many with significant exposure to global economics. Investments need to take into account global economics no matter where a stock is listed. It may be that a US company’s earnings growth is driven by emerging markets, whereas a Japanese listed stock is badly impacted by a US slowdown.
It is therefore important to have an understanding of global economics and where the opportunities for growth lie at all times. Companies with exposure to those high growth regions are more likely to produce earnings surprises and therefore outperform the market.
Within a global context, exposure to the US should therefore be driven by the quality of the companies against their global peers rather than physical location. It is unlikely that half of the best investment opportunities are going to be listed in the US at any time, no matter what the economic backdrop. This typically leads to an underweight position in the US.
It should be noted, however, that the current economic environment in the US has consequences far beyond the domestic market.

Hamilton: There has been much debate this year about the US economy, but we haven’t seen enough facts to materially change our generally positive outlook. The consensus forecast for GDP growth in America this year is now 2.2pc, and we expect a ‘soft landing’ for the economy. While this represents a slowdown after a prolonged period of high growth, it still represents a strong economic backdrop for corporate profits.
We believe North American equities offer an attractive combination of reasonable valuations and good growth prospects. The US economy and equity markets have absorbed some heavy blows over the past few years, but both the economy and corporate earnings keep growing, suggesting a deep underlying strength. We think the sentiment towards the US equity market will begin to change in 2007, and that the caricature of the US, as living far beyond its means, will start to fade. In simple terms investors will stop believing the stories and start responding to the facts.

Holt: The US represents more than 40pc of global equity markets’ capitalisation and includes more than 3000 quoted companies. Given the diversity of the US market, attractive opportunities exist even at times when the overall market may appear less attractive than other regions.
Of course, UK pension funds – particularly those retaining significant domestic equity bias or those which have chosen a global equity benchmark that is not based on market cap – may well have relatively limited US exposure anyway. In such circumstances we would certainly not advocate a further reduced US weighting. Instead we would suggest reducing the UK weighting – for example, to favour Asian equity markets, which continue to offer promising growth prospects.
However, we would at the same time caution against excessive focus on tactical allocation to regional markets at the expense of a sensible strategic allocation. All international markets are sufficiently diverse to present attractive investment opportunities – the skill, as always, is in identifying them.


Has China’s first quarter data prompted a rethink about the global outlook for 2007? Should this have any impact on pension fund investments?

Wilson: We have always believed that domestic consumption, based on continuing wage growth and the rise of a Chinese middle class, will provide a support to the Chinese economy even in the event of a US slowdown. As such, the first quarter data was no surprise, but instead reaffirmed our view that emerging markets, particularly China, will continue to be a significant driver of the global economy. Countries outside the Organisation for Economic Co-operation and Development are currently adding nearly $1bn (£503m) per year to global production – the equivalent to approximately 8pc of US gross national product growth. The impact this has on company earnings is often underestimated.
Pension funds should take advantage of this changing paradigm in global markets by giving managers greater flexibility. Investments should not be driven by geographical listing – which can often be an accident of history – but rather the strength of a company within its global sector. The combination of strong views on global economics and the sectors most likely to benefit from the prevailing environment gives the manager the best opportunity to outperform in the long term.

Hamilton: China is a concern in as much as there is little the authorities seem to be able to do about the rapid growth rate in the economy or the monetary stimulus that is driving it. They have raised rates and tightened reserves, but to little effect. While it is important to understand the effect of this growth on, for example, commodity prices, it doesn’t materially alter our view on the investment opportunities globally.
The corporate sector remains robust, with margins and returns at or near record levels in most regions. Interest rates remain relatively low, foreign exchange reserves continue to grow and corporate balance sheets are flush with cash. Liquidity abounds, and relative to the cost of debt, equity valuations remain attractive, particularly in the case of the mega-cap stocks. So, the strong case for arbitrage between debt and equity persists, which has led to significant merger and private equity activity. I believe this is a favourable backdrop for stock-pickers to really add value for their pension fund clients.

Holt: I expect no particular impact. While the downturn in February and early March was sharp (and arguably a sentiment-driven over-reaction), the subsequent rebound was swift and broad based. Given the long investment horizon of most pension funds, we strongly advocate strategic, patient approaches to asset allocation and risk allocation.
That said, the downturn served as an important reminder of the volatility associated with developing markets. However, we don’t feel it precipitated a broad reassessment of global asset allocation among most prudent, professional investors and plan sponsors.