GLOBAL - IPE has learned that pensions consultant Towers Watson is discussing the creation of GDP-weighted investable indices with product providers, to improve the efficiency of its clients' emerging market equity exposure.
The firm has long been an advocate of what it calls "beta prime", such as fundamentally indexation, and after conducting research into optimal solutions for emerging markets last year, it has concluded that GDP-weighting may be best route for implementation. It is in early talks with index-investment providers about creating such products.
"The next step is finding a manager that can provide the product at a price we think is right," said Craig Mercer, head of Towers Watson's emerging market equities and emerging market wealth team.
"There are firms like FTSE, Research Affiliates and MSCI that already construct similar indices, but if they proposed something that we didn't think was entirely efficient, we'd be happy to work with a partner to structure something that we think is correct."
Traditional market cap-weighted indices have been criticised for exposing investors to over-valued stocks and for being biased towards the momentum factor.
In emerging markets, these problems are compounded by the fact that they underweight some of the fastest-growing economies. China, which represents 9% of global GDP, makes up just 2% of the MSCI All-Countries Index, 18% of the MSCI Emerging Markets Index, and does not even make the MSCI World Index, for example.
"The broad conclusion is that GDP-weighted would seem to be the logical way of expressing what we want in client portfolios - which is that over the long-term China and India will become larger constituents of both the benchmark and the global economy," said Mercer.
"Next to MSCI Emerging Markets, a GDP-weighted index results in a strategic overweight to China and India, primarily. We think clients should be positioning portfolios to target that long-term change. It's about taking a strategic position rather than a market position."
There is still work to do - Towers Watson have yet to decide how they would weight individual stocks within countries, for example, or whether adjustments might be required to correct any mega-cap bias - and if a solution turns out not to be cost-effective Mercer acknowledges that this is an "evolving" area of research that they may return to at a later time.
But early indications for GDP-weighting apparently look good and it is hoped that product will be available "sooner rather than later".
In other news from Towers Watson, Gerard Roelofs has been appointed head of investment consulting for continental Europe.
Further analysis on the role of emerging market equities in pension portfolios as well as making emerging markets exposure more efficient will feature in 'Investing in Emerging Market Equities', in the February edition of IPE magazine.