Pension fund stamina tested as stocks look set to disappoint
While the Washington DC-based World Bank $9bn pension scheme has a relatively small weighting in US equities compared to its peers, it might be just as well if the US stock market falls over the coming year.
Sudhir Krishnamurthi, principal investment officer asserts that while the asset allocation philosophy is very much veered towards the long term, if the bond markets deliver as promised, the fund will seriously consider adjusting its weightings to suit. But Krishnamurthi admits, that regardless of equity performance, the US market is not one to dabble in lightly and withdrawing from the world’s largest market is no easy decision.
“It takes a lot of guts to pull out from the US market at this point in time and that’s been true for the last couple of years,” he says.
The World Bank pension fund’s allocation is divided exactly in half between the US and international markets, with an asset breakdown of 20% fixed income, 10% alternative investments, 65% equities and 5% emerging market debt and high yield.
“If you take it on just market capitalisation, I suppose that the kind of weights we have would be fairly reasonable,” he says, “More recently the US market has been doing extremely well -the valuations are very high and it has been an extremely difficult decision to pull out money from the US market.”
But Krishnamurthi is laying his bets on a downward spiral for US stocks. “My odds would be towards it going down, but we’ve all been saying that for the last year or so. The concern is earnings will start getting progressively more disappointing as we go down the road,” he says. He pinpoints the large corporates, certain parts of the banking industry, and “maybe technology” as the areas to be wary of as well as prevalent external influences. “The market tends to react fairly violently these days. I would expect that because of the South East Asian aspect predominantly as well as valuation levels, that there might be earnings disappointment - we might see valuations come down.”
He adds: “Just as bull markets go on a long time, bear markets also go on for a long time. So we’re in for a few more years of fairly little or modest returns from the US stock market.”
The picture is far rosier for bonds, however. “The flight to quality is definitely showing up” he insists. “Everybody will be piling on into the US which is still viewed as a safe haven. There is still little or no inflation in sight. The recent exchange rates, the dollar strengthening will mean that we will have a larger current account deficit but then I think imports will grow and therefore inflation will be kept down and if inflation is kept down, that is good news for the bond market.”
He attributes much of the bond markets’ forthcoming popularity to simply an alternative option for investors who are looking to withdraw from equities. “People will be worried about the equity market so they will get into the bond market” he says.
And one of the such investors will probably be World Bank themselves. “We have recently increased our bonds position and we obviously will look at the positions and if necessary increase it down the road.”
But if past experience is anything to go by, the fund won’t wait for the troubles to start before it makes its decision to re-weight its portfolio. The recent upsets in the world’s stock markets, left the fund’s allocation unaltered. That is because safeguards had already been put in place before the event.
“One thing which we had done, and this was done before the trembles, is put on some trades on the US equity portion of our portfolio, like a collar so we were protected on the downside,” he explains.
“These are fairly standard collar strategies so if you believe that the market is extremely overvalued and is likely to go down, but you don’t want to get out of the market, then these kinds of strategies can be done. And we did it because of the valuation levels in the US equity market, rather than because of any trembles that we have seen on the market recently.” Rachel Oliver