GLOBAL - Increasing globalisation means correlations between markets and returns of asset classes change frequently, Sudhir Rajkumar, head of the Pension Investment Partnership at the World Bank, has warned.
Pension funds should therefore not stick to markets and asset classes only because they have done so for the last years, Rajkumar pointed out at the IPE Awards Seminar in Vienna yesterday.
"The question is are you exposing yourself to diversification or to contagion," he said.
He added market crises, including the most recent subprime debacle, showed "diversification benefits can disappear quickly".
"To invest prudently, pension funds have to go outside their own markets but they have to make sure the risk they take is within their institutional risk tolerance."
While stressing these were his own opinions and not those of the World Bank, Rajkumar urged funds to keep a close eye on correlation as increasing globalisation brought with it structural shifts in the market.
Other issues pension funds had to watch out for, he suggested, as globalisation continues are how much and which asset classes should be hedged.
Furthermore, he noted the difficulty of how corporate governance and social responsible investment principles translate across borders.
This includes the question of how receiving countries should react to investments by sovereign wealth funds.
Rajkumar noted some of these funds may not be viewed by some countries "as investing for purely financial reasons and therefore as less transparent".
He pointed out in 2012 around $16trn (€11trn), or 12% of all global financial assets, will be in sovereign wealth funds which are currently predominantly invested in government bonds.
As they start to shift into equities, there was a view suggesting the equity risk premium may go down as a result, he pointed out.
"Other investors will have to include this into their asset allocation calculations," Rajkumar added.