Institutional investors are no strangers to international investing, but that doesn’t stop the big boys from rediscovering foreign equities every so often. Are we in the middle of one of those rediscovery moments now?
Indeed we are, suggests a recent report from Greenwich Associates, a consultancy for institutional investors. International equity holdings rose 30% over the past 12 months to over $620 billion among U.S. institutions. Among the catalysts driving large investors offshore, Greenwich opines, is the 21st century’s increasingly desperate search for performance that’s something more than mediocre. Because so much money is so ambitious in chasing results, the usual suspects in asset allocation aren’t doing the trick, namely, heavy domestic weightings in stocks and bonds.
Foreign stocks, relative to their U.S. counterparts, seem inclined to deliver a higher plain of satisfaction. Consider that for the 12 months through the end of June, the MSCI EAFE Index, a cap-weighted benchmark of non-U.S. developed equity markets around the world, posted a 14.2% total return. That’s more than double the S&P 500’s 6.3% total return over that stretch. The foreign edge was even stronger for equity markets in developing countries. The MSCI Emerging Markets Index delivered a 33.4% total return for the year through last month.
The obvious allure of foreign stocks these days is superior returns relative to the U.S. No one needs a reason to pursue greater performance. But it doesn’t hurt the flow of dollars into offshore securities that in some corners of institutional investing there’s an extra zing in the natural incentive to reach for yield and capital gains. Underfunded pension/benefits funds, for example, keep the strategists plying the investment waters for ways of circumventing mediocrity. In a press release distributed by Greenwich, John Webster, a consultant with the firm, advises that “U.S. pension funds are under significant pressure to generate alpha [returns above the benchmark], and there is a widespread perception among institutional investors that overseas stocks are undervalued.” Webster goes on to say that an expected 50 to 60 basis points of additional return is lying around for consumption in the world of international equities relative to U.S. stocks.
The optimism that there’s better hunting overseas is debatable, but no one’s disputing the motivation that springs from underfunded pension/benefits funds as a reason to look beyond traditional asset allocations for performance deliverance, illusory or not. Clyde Milton of the Cheap Stocks blog dives into the gritty details by pulling apart General Motors’ pension fund as an example. Milton, taking numbers from the automaker’s public filings, observes that the company’s benefit obligations globally are in the red to the tune of nearly $70 billion. But as frightening as that is, “Perhaps the most alarming aspect of GM’s situation is the company’s own expectations…” he writes. That is, return expectations for the company’s pension/benefit plans around the world ranging from 8% to 9%. “While these projected returns seem achievable on the surface, in the context of GM’s asset allocation strategies, they are overly optimistic, at best,” Milton charges.
How can a large institutional investor pull an 8%-to-9% nominal return rabbit out of its portfolio hat? Raising portfolio allocations to real estate and other so-called alternative investments is one way. Who knows? It may even work. No wonder then that GM’s U.S. plan has 8% committed to real estate and 10% to “other.” Equity, meanwhile, has just 47%, based on the firm’s most recent annual 10K and 10Q reports filed with the SEC. Although GM doesn’t break out its domestic and foreign mix of equities, arguably the firm needs an aggressive allocation of the latter if the Greenwich assumptions are accepted at face value.
Of course, even a strong performance from overseas stocks may not keep GM from tapping its earnings to keep its promises with benefits obligations. But the fact that GM isn’t alone in needing to come up with some extra cash flow in its pension funds going forward suggests that more than a few of America’s corporate titans may be looking to international equity allocations to keep shareholders happy, and earnings rising. As such, the allure of overseas stocks may roll on for some time.