Portfolios disadvantaged by developed markets

Media Release

Investors’ equity portfolios disadvantaged by focus on developed markets

Monday 20th September 2010

Institutional investors are limiting returns and retaining unnecessary risks in their equity portfolios by continuing to bias investment towards developed economies, says Mercer.

In its paper, A blueprint for improving equity portfolios, Mercer calls on institutional investors to carry out a fundamental review of their equity portfolios to ensure they remain “fit for purpose” in the economic landscape post the financial crisis.

The continued strong growth in developing countries with favourable features such as young and expanding populations is not being captured adequately by many investors. A strong bias is still evident towards countries suffering from structural disadvantages such as excessive public debt burdens and weak bank lending.

Nick White, Principal in Mercer’s Investment Consulting business, said the growth trajectory of developing countries was only briefly interrupted by the financial crisis, whereas many developed economies now face public, corporate and private debt issues that will take many years to work through. These, combined with increased regulation and the potential for policy errors, are likely to act as a brake on economic growth in the developed world.

“Equities continue to be a significant component of most portfolios, but investors should ensure they have access to broad equity market returns. The problem is that many equity strategies are biased in favour of developed countries and also large cap stocks, and this is likely to increase fundamental risk and may compromise returns,” Mr White said.

“We appear to be in the early stages of a fundamental rebalancing of the global economy. Whilst this may not be guaranteed, it is a brave investor who would take such a significant bet against the emerging world and other growth engines.

"Investors need to ensure their equity portfolios are sufficiently diversified with exposure to as many forms of risk premia as possible. This will ensure their portfolio will be more resilient in the face of any unforseen market dislocation," he said.

Mercer’s research outlines that there is a strong argument for diversifying away from large cap developed markets in a rational way to preserve performance potential and to improve the efficiency of portfolios. This is likely to involve an increased exposure to emerging, small cap and low volatility strategies.

“Australia’s relatively strong economic performance compared with other developed economies owes much to the performance of the emerging markets, and specifically, China. Australian clients’ home biases clearly provide an indirect exposure to the emerging markets. However, it is in clients’ best interests to increase their direct exposure to the emerging markets to ensure they capitalise on the emerging markets story, which could be in play for many years and decades to come,” Mr White said.

“There are significant implications for portfolio structuring, which we are encouraging investors to focus on, that will produce better global equity portfolios for the future,” he said.

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