Managers anticipating huge demand

More pension funds expected to embrace the strategy in the next five years

Nov 8, 2009 @ 12:01 am

By Thao Hua

Money managers are adding more arrows to their emerging-markets quiver as they anticipate institutional investor demand for such strategies to escalate. “My sense is that there are adequate products for the interest you have today, but that will change in the midterm period [of about five years], in which you'll have enhanced demand,” said Paul Matson, executive director of the $23 billion Arizona State Retirement System. “Furthermore, as emerging markets improve their domestic infrastructures, there will be more opportunities from the supply side and as a result, more products available.” Consultants expect more pension funds to allocate to dedicated emerging-market strategies within the next five years. “The magnitude of those allocations” will also increase, said Terry Dennison, a worldwide partner and U.S. director of consulting at Mercer Investment Consulting. “Instead of the current 5% range, [institutional investors] will probably be looking at 10% to 15% of total assets, and it will be strategic rather than tactical.” Other consultants and managers said that in the longer term, developing nations might account for as much as 35% or more of an entire portfolio. Managers that have been dedicating more resources to emerging-markets teams and products to capture this potential include Aberdeen Asset Management LLC, The Boston Company Asset Management LLC, Goldman Sachs Asset Management, J.P. Morgan Asset Management, Pacific Investment Management Co. LLC, and T. Rowe Price Group Inc. Others, such as emerging-markets specialists Franklin Templeton Investments and Ashmore Investment Management Ltd., also are reaping the benefits of increased investor interest. The firms reported $12.2 billion and $3.6 billion in net asset inflows, respectively, for the quarter ended Sept. 30.

“Institutional investors are gradually increasing allocations to emerging markets or thinking about [adding exposure] as part of a broader portfolio restructuring,” said Mark Mobius, executive chairman of Franklin Templeton, which manages about $30 billion in dedicated active emerging-markets strategies.

Consultants said that institutional investors and managers are likely to use relatively liquid asset classes such as equities, fixed income and currency to get the potential returns offered by growing emerging markets.

So far, pension fund executives have been putting bigger bets on the equity markets than emerging-markets fixed income, but consultants expect to see more demand for the latter in the next few years. The case for emerging-markets debt is based on long-term improvements in economic fundamentals in these countries, leading to higher credit quality, lower borrowing costs and more liquidity, said Craig Mercer, a senior investment consultant within the global manager research team at Watson Wyatt Worldwide. An exposure to local-currency debt allows investors to benefit from any appreciation of emerging-markets currencies relative to G7 currencies, he said. Some managers have been hiring to boost their emerging-markets fixed-income teams. For example, Pimco has gone to 10 global portfolio managers, from eight, since the second half of last year. The firm introduced a dedicated emerging-markets product last year targeting companies involved in infrastructure projects, and plans to launch a separate Asian emerging-markets-debt strategy next year.

DEBT IS ATTRACTIVE

Emerging markets also feature highly in Pimco's Global Advantage Bond Index, which is gross-domestic-product-weighted rather than being based on market capitalization and includes a broader set of fixed-income instruments.

Aberdeen Asset Management's emerging-markets team grew by two investment professionals — one in the emerging-markets-debt team and the other in the global-emerging-markets division — as a result of its acquisition of Credit Suisse Asset Management's U.K. business at the end of last year.

Goldman Sachs Asset Management is also planning to strengthen its operations in Brazil. Firmwide, the emerging-markets team has expanded to 25 investment professionals based in seven international offices, compared with 11 professionals in two offices five years ago.

Elsewhere, J.P. Morgan Asset Management has added three investment professionals to its emerging-markets team so far this year, including Pierre-Yves Bareau as head of emerging-markets debt. Mr. Bareau had been chief investment officer of emerging-markets debt at Fortis Investments.

No products have been launched in the United States this year, but J.P. Morgan officials are considering adding a small-cap to mid-cap emerging-markets-equity strategy.

Assets under management at J.P. Morgan Asset Management have doubled since January, while emerging-market assets have generally risen about 60%, said Tom Leventhorpe, vice president of global emerging markets.

He declined to provide specific figures for assets under management dedicated to emerging markets, citing company policy.

“Years ago, investors could ignore emerging markets and it did not particularly matter,” Mr. Leventhorpe said.

“Given the fact that returns in emerging markets have tended to outpace developed markets ... it be-comes much harder to ignore,” he said.

ROBUST DEMAND

Demand for developing market equity will remain robust, consultants and managers said, but what is becoming increasingly important for emerging-markets equity managers is to add alpha from a bottom-up perspective.

“In the past, there has been more top-down, country-specific value to be had” for active emerging-markets managers, said Deborah Clarke, principal in the manager research division of Mercer LLC.

“That's diminishing,” she said. “What we're seeing more now is a bottom-up approach.”

T. Rowe Price's bottom-up emerging-markets strategies have grown nearly fivefold in as many years to $18.3 billion in assets under management as of June 30, compared with about $4 billion five years earlier, according to Peter Preisler, a director and head of Europe, Middle East and Africa operations for the firm.

The firm added Africa and Middle East strategies about two years ago but stayed away from “four-letter type strategies, such as BRIC,” he said.

“We think it has limited appeal to institutions, which tend to use regions as building blocks as part of a broader strategy,” Mr. Preisler said. “Why should one want to invest in Brazil but not Chile or China and India but not Thailand and Indonesia?”

Axa Rosenberg Group LLC — also a bottom-up equity manager — added a dedicated global-emerging-market strategy three years ago. As of June 30, the strategy had $1 billion in assets under management, up from about $700 million at yearend 2008.

The firm has another $2.1 billion in emerging-market assets within broader global strategies, which is also gaining inflows.

“Clearly, more money is finding its way into emerging markets,” said Simon Vanstone, Axa Rosenberg's chief executive in Europe.

“Are people increasing on a tactical basis? Yes. My sense is that in the last year, there has been an increase to emerging-markets strategies, although more commonly as part of a wider global or international remit,” Mr. Vanstone said.

Thao Hua is a reporter for sister publication Pensions & Investments.

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