Super Funds Should Prepare For New Risks As They Outgrow Domestic Equity Markets
Australian super funds need to be aware of challenging nature of global equity markets
New research paper from the US-based implementation specialist fund manager, Parametric, shows that the growth of the Australian superannuation pool will drive super funds to access global equity markets that are 57 times larger than our domestic market.
However, there are challenges in global equities that have not been fully realised, mainly the differences between Developed Markets (DM) and Emerging Markets (EM).
The research paper titled ‘Expanding equity horizons: the critical new asset allocation decision and how funds can get it right’ highlights that super funds will need to up-scale equity investing capabilities due to the continued nature of defined contributions (long-term investment horizon/guaranteed capital) and the growing retirement savings gap (need for high-growth).
Global head of investment strategy at Parametric, Tim Atwill says: “Given this characteristic of the superannuation sector, some large super funds have already outgrown the Australian equity market. As they increasingly look offshore for equity opportunities, the new, critical decision to get right is how to allocate to DM and EM.”
This Parametric paper examines the decomposition of cross sectional volatility (CSV) of the MSCI World Index, as a proxy for the investable universe in the international developed markets. Results make the case for a distinct EM approach, while DM equity performance is driven by several different risks which change through time.
The singular, persistent characteristic of EM equities is that country allocation is the primary driver of returns and its impact dominates through time.
Managing Director Research (Australia), Raewyn Williams says: “This insight is important to super funds as a reminder to treat EM allocation and manager/strategy selection decisions as a separate, defined process to DM.”
“Super funds need to focus on this as a first order issue on the country allocation characteristics of a prospective EM strategy and not to waste a valuable time and fee budget on EM strategies whose ‘bells and whistles’ are in sector or style factor management, but not country selection.”
Parametric’s findings also challenge super funds who use a passive, index-tracking country weighting EM strategy.
Atwill adds: “Such strategies have no ‘country smarts’ and can dangerously concentrate a super fund’s country allocations in just a handful of EM countries, rather than diversifying bets across the EM universe.”
Williams notes that 13 years ago, the US and UK together held 53% of the world’s total listed equities, compared to China and India’s 2.3%. “Today (13 years later), the US and UK’s percentage of total world listed equities has slipped to 40.9% and China plus India’s has grown to 12.7%.”
She highlights a number of key messages for super funds from this research.
“Superannuation funds can use these insights to hone their EM equities approach in the search for better returns, lower risks, reduced fees, better tax efficiency, greater transparency or any combination of these wins.
For passive investors, a good response will be to focus on getting more country diversification into their portfolios.
For active investors, the response should be about ensuring they spend the super fund’s time and money on what will really drive the EM portfolio’s outcomes – thoughtful country allocation,” says Williams.
Parametric Portfolio Associates® LLC ("Parametric"), headquartered in the United States in Seattle, Washington, with Australian offices at MLC Centre, Suite 6502, 19-29 Martin Place, Sydney NSW 2000, is registered as an investment adviser under the United States Securities and Exchange Commission Investment Advisers Act of 1940. With over $192.8 billion USD of assets under management as of 28 February 2017, Parametric is a global asset management firm offering investors a variety of portfolio solutions, including tax-managed centralised portfolio management, tax-managed indexing and factor investing strategies, as well as emerging markets and defensive equities strategies. Parametric Australia is a division of Parametric Portfolio Associates® LLC that is a majority-owned subsidiary of Eaton Vance Corp, one of the world's most dynamic global asset management companies.
Parametric is exempt from the requirement to hold an Australian financial services license under the Australian Corporations Act 2001 (Cth) (Corporations Act) in respect of the provision of financial services to wholesale clients as defined in the Corporations Act and the Australian Securities and Investments Commission's ("ASIC") Class Order 03/1100. SEC rules and regulations may differ from Australian law. Parametric is not a licensed tax agent or advisor in Australia and this does not represent tax advice.
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