Mercer prompts risk–return rethink for global equities

With the dust hopefully settling on the financial crisis, super funds should take the opportunity to rethink how they put together and benchmark their global portfolios in keeping with the way the world is developing, according to Mercer Investment Consulting (Mercer IC). A seminal paper published by Mercer IC last month urged pension funds around the world not only to question their standard global equity benchmarks but also to look at better ways to protect their positions in down markets. The net result, for funds which go down this path, would lead to a new way of looking at asset allocation – focusing on risk premiums rather than allocations to buckets of asset classes – and a new form of portfolio construction whereby defensive assets were redefined to better do the job in times of stress when correlations head to one.

The paper, A Blueprint for Improving Institutional Equity Portfolios, was written by Sydneybased director of consulting – Asia Pacific, Nick White, with input from researchers and consultants in Mercer IC’s European and North American offices. The paper pointed out that the standard MSCI World equities benchmark was massively skewed towards the developed world, particularly to the US, and as such was likely to miss out on the probable growth pattern of world markets in the medium-to-longterm. White said the global economy appeared to be in the early stages of a fundamental rebalancing and advised investors betting against the rise of the emerging markets and other “growth engines” to reconsider their assumptions. He said that some clients had already moved away from the MSCI World, adopting the broader MSCI ACWI (all country) benchmark, but even this underweighted stronger growth small-cap stocks.

If you follow the global theme, he said, you end up with something like the old Citigroup broad market index of investable markets, which included both emerging markets and small-caps. On the portfolio construction side, Mercer suggested funds look at offsetting the potentially bumpier ride of greater exposure to emerging markets and small-caps through an allocation to lowvolatility strategies. There were various ways to achieve this, such as low-volatility stocks, quality stocks (with high pricing power and good dividend records) or even an old-fashioned mandate giving managers the authority to go to cash when they thought it was appropriate. Such mandates were designed to at least keep within reach of the growth-oriented parts of the portfolio over the long-term while providing relatively better performance in times of stress.