UK – UK plan sponsors’ portfolios would add value by substituting international fixed income in place of international equity, according to new research by Rogge Global Partners.
In a study - “Fixed Income: A better choice for your international allocation” - Rogge cites a larger allocation to international fixed income as a means of increasing returns.
“A larger allocation to international fixed income will increase the level of stability and is very likely to increase the total return of the fund which is critical in this era of declining funding ratios,” says the report.
Rogge believes that international equities will continue to struggle in the post-equity bubble environment, and that issues of corporate governance, lack of corporate pricing power, high corporate debt and geopolitical uncertainties will weigh on the performance of international equity for the foreseeable future.
A global environment of stable inflation, however, is reducing the risk associated with fixed income assets. This environment and more developed capital markets (particularly in emerging economies) will help to support government bond markets, says Rogge.
For UK plan sponsors with a large international equity allocation, the use of an active investment strategy has not added value but has, rather, made the performance gap with international fixed income even larger.
International equities have also not performed well in terms of providing diversification benefits to UK investment plans, which typically have the largest portion of their assets in UK equities. During the past 10 years the correlation of international equities to UK equities has been high at 0.82 – far higher than that of any other two asset classes. This correlation is rising, says Rogge. For the five years ending September 30,2002, the correlation rose to 0.92.
International fixed income, on the other hand, has been an excellent diversifier for UK equity with correlations of –0.27 and 0.07 during the past five and 10 years respectively, says Rogge.
Asset class volatility is another measure whereby international fixed income appears to have made a more useful contribution to the overall investment plan than international equity. The volatility of international fixed income has generally been declining in recent years while that of international equities has generally been rising.
The impact of altering the international asset mix of the average UK plan sponsor on returns is significant, says Rogge. If the average UK pension plan had allocated its entire international exposure (around 31.5%) to fixed income, then returns of the 5-, 10- and 15-year period up to September 30, 2002 would have been significantly higher, 1.02% compared to –0.95% for the five-year period.