On the Record: Are you rebuilding your emerging market portfolio?
Christer Franzén, Chief investment officer
• Location: Stockholm
• Assets: SEK20bn (€2bn)
• Type: Swedish pension foundation for domestic employees of Ericsson
We divested from emerging markets three to four years ago and China was the reason for divesting our allocation at the time. We realised it had reached its peak in terms of growth, and we concluded that other areas would be affected, which led us to divest from commodities and other emerging market countries as well. We believed it was better to be invested in companies from developed markets that had exposure to emerging markets, due to better corporate governance and compliance. It was a safer bet, even though the underlying growth story was the same.
Over the last couple of years, cheap funding has been a potential future danger for everyone. Emerging market countries are not immune from the actions of leading central banks, chiefly the US Federal Reserve. The Fed may have to step up its hiking cycle, and rates rising fast may have negative implications for many emerging markets.
To get exposure to economic growth in emerging markets, we used to favour companies from developed countries which had a connection to emerging markets. However, local and global competition has become stronger from many points of view. We would look at emerging market corporates that have potential to compete with developed market ones.
In general, we feel that many of the traditional emerging market countries have not been able to address their future challenges. There is an argument that emerging markets is the only area where economic growth is likely to continue at reasonable levels, but for that to be true, there needs to be a correct approach to de-regulation as well as democracy and human rights. There are technological trends, such as the advances in robotics and automation, that may play against emerging markets.
In terms of modernisation, there are some shining lights. I believe India is an example of the correct approach to growth. They have taken important steps forward, such as being able to identify people, providing them with bank accounts and also implementing a new bankruptcy legislation. This is of paramount importance to attract foreign investment as well as developing the domestic business sector.
For the future, we will probably not look for exposure on a country or regional basis. We will continue watching global companies that are exposed to growth in both developed and emerging markets. Such companies may well be hailing from emerging market countries.
Christoph Schlegel, Head of pension investments
• Location: Munich
• Assets: €5.9bn
• Liabilities: €6.9bn
• Multinational corporate pension fund
We have always been a fairly large investor in emerging market debt. In terms of emerging market equity, because we tend to give global mandates to our equity managers, the decision to overweight or underweight emerging market equities is somehow taken away from us. We focus on the debt, and at times over the past years it has been tough. We have invested in both hard currency and local currency sovereign debt and corporate debt. We have kept our exposure through the most difficult years, because we did not believe we would have been able to time the turning point. And eventually it has come: this year has been very good for our emerging market debt portfolio so far, except for January and February.
In terms of risk management, the main instrument we use is diversification. We give segregated mandates and give our managers limits – for instance, in terms of maximum holding sizes for sovereign and corporate or ratings. We are not in the business of predicting which countries or sectors will outperform. However, we can fairly easily achieve the correct level of diversification.
Two managers currently invest in emerging market debt on our behalf. One focuses on hard currency corporate debt, the other also invests in local currency debt, and has a more dynamic style of investment.
For us, emerging market debt is a strategic investment. It is one of the few areas of the wider fixed-income markets where investors can get some yield. That, I would say, reflects correct pricing of fundamentals. In other words, when you invest in emerging market debt you know are buying risk, but you get a reasonable yield in return.
We do not decide a priori which countries or sectors we should overweight or underweight, but we have abandoned the standard market indices, and designed an investment process that we think is better. We design a custom benchmark based on risk and certain economic factors, and allow for higher allocation where the risk is lower. In designing our strategic asset allocation, we work with scenarios. We do not have a special scenario to evaluate the emerging market allocation. We may model a global recession, a rise in US Treasuries or deflation scenario and evaluate how emerging market are likely to behave. In general, we find that the scenario-weighted risk and return are good for emerging markets, and that is the reason why we invest.
Livio Raimondi, Chief investment officer
• Location: Milan
• Assets: €2bn
• Members: 25,000
• Type: Open defined contribution (DC) fund
We recently introduced an allocation to emerging market equities in our portfolio. This is the most significant change in the new strategic asset allocation, which we approved earlier this year. It is also the first time we invested in emerging markets. Historically, Italian regulation did not allow pension funds to invest in non-OECD [developed] countries, but this changed at the end of 2014.
Our decision to invest in emerging markets was driven by two factors: first, our search for diversification. Emerging markets are more correlated from developed markets than they used to be, but they are still a good diversifier. Second, we felt that this was a relatively good entry point for emerging market equity, which has underperformed developed-market equities for the past five years.
Like most Italian pension funds, we tend to make new investments gradually. We began with a target allocation of 5-7% of our equity portfolio. We have invested in a diversified way, without a specific geographic or sector focus. The allocation has been implemented through [pan-European] UCITS funds. This allocation has been made at the expense of our developed market equity portfolio.
We did not allocate to emerging market debt, even though some regional debt markets looked attractive. But we feel that emerging market debt is too volatile an asset class for our fixed-income portfolio which for our purposes should provide stable income. Investing in emerging market debt also implies being exposed to currency risk, and regulation restricts the level of currency exposure we can run. We do not rule out investing in emerging market debt in the future, but we are more likely to increase our equity allocation first.
The equity funds we have invested in are actively managed, and use the MSCI Emerging Market index as a benchmark. I believe emerging market funds are among the few that search for active returns and show high tracking error levels. In other words, we think that is where alpha can still be found.
I think the main risk in investing in emerging markets is that each country is on a different growth path. There are several imbalances within the sector, and this is different from the past, where these countries grew in a more homogenous way. But economic growth in emerging markets is likely to continue at higher multiples compared to developed, albeit more slowly than in the past.
Interviews conducted by Carlo Svaluto Moreolo