Mercer argues investment case for two-speed world

Consultancy Mercer is urging investors to adjust weightings to better reflect a two-speed world economy, saying some need to raise emerging-market exposure up to 10 times present levels.

Simon Eagleton, Mercer’s Asia-Pacific business leader for investment consulting, notes that despite a strong economic argument, many institutions have maintained allocations in line with global market-cap weightings, meaning a heavy bias towards slower growing developed markets.

“It’s not all that long ago that the global financial crisis was here, and luckily risky assets did rebound,” he tells AsianInvestor. “So many [investors] would have seen their portfolios recover handsomely without really any changes to their asset allocations.”

He is a firm believer that market capitalisation is a backward-looking measure, describing firms that follow such an investment strategy as essentially momentum investors.

“What you would ideally like to do is build a strategy that anticipates what the market cap will be in 10-20 years’ time,” he adds. “That is what you should be investing in today.

“No one knows exactly what is going to happen, but you can make some informed estimates relative to economic leadership, demographic momentum and acknowledging the kind of problems that the developed world has financially.”

As a firm, Mercer believes it is better to allow managers greater conviction to make calls as opposed to a benchmark strategy, because on the whole it says that will lead to better returns.

But Eagleton believes it is not enough just to rely on active managers to generate a forward-looking strategy. “I think strategically overall equity asset allocation needs to be forward-looking, as well as using active managers,” he says.

“Alpha is a very attractive thing to have in a portfolio. A manager’s skill is unrelated to the movement of capital markets, and the more you have of it, the more stable your returns will be.”

He urges investors in Asia and globally to build a more meaningful allocation to emerging markets, not just in equities, but in debt and many alternative asset classes.

“We would like to see our client base with much higher exposure to emerging markets, perhaps 10 times what they would typically have,” he says.

However, he concedes that time-horizon is a key factor, given that emerging market equities are not considered cheap on a relative basis. “Is this the best time to take a massive overweight to emerging markets? Probably not.

“I would not want to see a client with all their equity exposure to developing markets. But in conditions where you get economic growth, you tend to get earnings growth.”

The Mercer approach to equity allocation would see clients add exposure to emerging markets and global small-caps to capture the growth story, and offset that with low volatility-type strategies.

In terms of fixed-income investing, Eagleton notes that investors have typically held bonds as a diversifier and a crisis protection measure.

“But in a world where some sovereign debt is currently priced at levels that would suggest it is far riskier than corporate debt – and in Asia we have many sovereign investors and central banks with huge allocations to other countries’ sovereign debt – maybe they need to be thinking about a smarter way to allocate,” he adds.

Eagleton says it would be no surprise to see such investors increase allocations to investment grade credit as well as to emerging market sovereign debt.

Mercer is preparing to stage its Global Investment Forum 2011 in Singapore on March 4. On the event, Eagleton adds: “These things have been widely discussed during the crisis, but we have not seen significant changes in investors’ behaviour in response to that. We are not saying we have the answers, but we want our clients to discuss this.”