City of Fresno Retirement System

Transcription

1 City of Fresno Retirement System Emerging Markets Educational Presentation December 16, 2013 Don Stracke, CFA, CAIA, Senior Consultant Allan Martin, Partner Tony Ferrara, Senior Analyst

2 Table of Contents What are emerging/frontier markets Why are we investing in emerging markets Case for small cap emerging market exposure Case for frontier market exposure Summary 2

3 Developed vs. Emerging

4 What constitutes an Emerging Market? The MSCI Market Classification Framework consists of the following three criteria: economic development, size, and liquidity as well as market accessibility. In order to be classified in a given investment universe, a country must meet the requirements of all three criteria as described in the table below. 1. Economic Development Criteria Frontier Emerging Developed Sustainability of economic development No requirement No requirement Country GNI per capita 25% above the World Bank high income threshold* for 3 consecutive years 2. Size and Liquidity Requirements Number of companies meeting the following Standard Index criteria Company size (full market cap)** USD 505 mm USD 1010 mm USD 2020 mm Security size (float market cap)** USD 35 mm USD 505 mm USD 1010 mm Security liquidity 2.5% ATVR 15% ATVR 20% ATVR 3. Market Accessibility Criteria Openness to foreign ownership At least some Significant Very high Ease of capital inflows/outflows At least partial Significant Very high Efficiency of the operational framework Modest Good and tested Very high Stability of the instituitional framework Modest Modest Very high The economic development criterion is only used in determining the classification of Developed Markets while that distinction is not relevant between Emerging and Frontier Markets given the very wide variety of development levels within each of these two universes. The size and liquidity requirements are based on the minimum investability requirements for the MSCI Global Standard Indices. Emerging Markets country indices with fewer than three companies meeting the Emerging Markets size and liquidity requirements for four consecutive Semi-Annual Index Reviews will be reclassified as Frontier Markets. *High Income threshold for 2009: GNI per capita of USD 12,196 (World Bank, Atlas method) **Minimum in use for the May 2011 Semi-Annual Index Review, updated on a semi-annual basis Source: MSCI 4

5 Which Countries are Emerging Market Economies? 21 Markets Emerging Market Economies are generally defined by having low to mid GDP per capita or per capita income 23 Developed Countries 34 Frontier Countries Source: MSCI 5

6 Emerging Market Allocations Emerging markets comprise roughly 13% of global equity markets We believe clients are currently under allocated to emerging markets and should look to be at least market weighting Strategies benchmarked to the large cap or broader indices may not be exploiting the consumption opportunity Consider investing in emerging market small cap or domestic consumption linked strategies When increasing allocations there is an opportunity through EM small cap to better exploit the rise of the emerging market consumer Few managers in the space, opportunity to partner with top tier investment teams to launch commingled products at a fee discount. Frontier Markets may be used to compliment an existing well diversified emerging market allocation Markets are not well defined and strategies are capacity constrained and illiquid 6

7 Why are we investing in Emerging Markets

8 The Emerging Markets Lead World Real GDP Growth 2013 World Real GDP Growth Projections (%) Source: International Monetary Fund 8

9 EME Valuations are Historically Cheap Emerging Markets Forward P/E 30 MSCI EM + Std. Dev. - Std. Dev. 25 Mean 20 Fwd P/E Source: MSCI 9

10 EME Valuations are Historically Cheap 3 Emerging Markets Price/Book Price/Book MSCI EM Std. Dev. - Std. Dev. Source: MSCI 10

11 to-7 Year Return Forecasts Geometric Expected Return Asset Class Cash 1.25% 0.75% -0.50% Treasuries 1.50% 1.00% -0.50% IG Corp Credit 4.50% 3.00% -1.50% MBS 3.25% 2.50% -0.75% Core Bonds* 2.88% 2.04% -0.84% TIPS 1.75% 1.50% -0.25% High-Yield Bonds 7.00% 5.00% -2.00% Bank Loans 5.00% 5.00% Global Bonds (Unhedged) 1.25% 0.75% -0.50% Global Bonds (Hedged) 1.49% 0.93% -0.56% EMD External 5.75% 4.00% -1.75% EMD Local Currency 6.75% 5.00% -1.75% Large Cap Equities 7.25% 6.75% -0.50% Small/Mid Cap Equities 7.50% 7.00% -0.50% Int'l Equities (Unhedged) 7.75% 7.75% Int'l Equities (Hedged) 8.00% 8.00% Emerging Int'l Equities 9.75% 9.75% Private Equity 9.75% 9.00% -0.75% Private Debt 9.50% 8.50% -1.00% Private Real Assets N/A 8.00% Real Estate 6.00% 6.00% Commodities 4.75% 5.00% 0.25% Hedge Funds Low Vol 5.50% 4.75% -0.75% Hedge Funds Mod Vol 7.25% 6.50% -0.75% * Core Bonds assumption based on market weighted blend of components of Aggregate Index (Treasuries, IG Corp Credit, and MBS). 11

12 Case for small cap

13 What is Emerging Market Small Cap? There is not one specific market cap cut off by country MSCI defines the universe as approximately the bottom 15 th percentile by market cap within each local market Liquidity and Free Float vary by market resulting in a different market cap cut off per country Down the cap spectrum you gain less exposure to SOE s (State Owned Enterprises) We define the universe loosely as below $3.5 billion in market cap The MSCI Emerging Markets Small Cap Index is the most widely accepted benchmark in the space (MSCI EM SC) The MSCI EM SC universe consists of roughly 2,000 securities, much larger than the MSCI EM universe roughly 800 securities Sell side research for the asset class is low and public information is not widely communicated This offers an opportunity for active management to add significant value The asset class offers a way to better exploit the emerging market consumption theme 13

14 Based off Current Trends Middle Class is expected to grow by 460 million people Source: GMO 14

15 Emerging Market Spending Growth Projected Growth in Disposable Income, (% change) Source: Bloomberg News, Allianz, CLSA 15

16 The Consumption Story Has Worked 40% Cumulative Returns (12/31/2010-8/30/2013) 30% 20% 10% 0% -10% -20% MSCI EM Consumer Staples Consumer Disc Healthcare -30% Dec-10 Jan-11 Feb-11 Mar-11 Apr-11 May-11 Jun-11 Jul-11 Aug-11 Sep-11 Oct-11 Nov-11 Dec-11 Jan-12 Feb-12 Mar-12 Apr-12 May-12 Jun-12 Jul-12 Aug-12 Sep-12 Oct-12 Nov-12 Dec-12 Jan-13 Feb-13 Mar-13 Apr-13 May-13 Jun-13 Jul-13 Aug-13 Source: Bloomberg 16

17 Key Sector Exposure Differences Down the Cap Spectrum Down the cap spectrum there is greater exposure to the consumption theme, particularly the emerging market consumer Source: MSCI 17

18 Emerging Markets Equity Sizing the Market Index Characteristics Wtd Ave Market Cap (US$$m) MSCI EM MSCI EM Small Cap 31, Median Mkt Cap (US$$m) 3, Total # of Stocks 820 1,905 BRIC Allocation (Brazil, Russia, India, & China) 45% 30% Biggest Country China Taiwan Energy and Materials Allocation 27.4% 16.3% Consumption Based Sectors 17.2% 31.9% 18

19 EM Standard Deviation 6/30 Source: evestment 19

20 Median Excess Return by Asset Class When considering active management global equity, developed small cap, and emerging small cap appear to have the highest alpha potential Median Excess Manager Retrun 9% 1 Year 3 Year 5 Year EAFE Core 8% 7% 6% EAFE Value EAFE Growth EAFE Small Global Equity EM EM SC 5% 4% 3% 2% 1% 0% -1% Source: evestment as of 12/31/12 20

21 Case for frontier markets

22 What Are Frontier Markets? The simplest definition: countries that are not regarded as developed or emerging as defined by the investable indices For our purposes, markets must be investable Defined by characteristics: countries that are in the early stages of developing liquid equity markets and foreign exchange markets In some cases, low analyst coverage, and some market restrictions Defined by region: frontier markets are regionally focused on the Middle East, portions of Latin America, Eastern Europe, and Africa 22

23 Investment Thesis Frontier markets provide a diversified portfolio potential for excess return relative to emerging markets Provides an opportunity to gain a first mover advantage Capture the benefits of improving economies, rapidly growing markets, global integration, and increasing foreign investment The commodity boom reduced countries debt and generated individual wealth This wealth has slowly trickled down throughout the economy and has helped generate a rising middle class; the increased wealth of the individual has resulted in increased consumer spending as well as investing Frontier stocks are primarily driven by the local investor in addition to local economic and political dynamics These local drivers push inter-country correlations down (e.g., Venezuelan politics don t affect Vietnam's employment rate), which has the effect of reducing the systematic risk of the category as a whole As the frontier countries continue to experience economic growth and global integration, our view is that these correlations as well as volatility will increase Frontier Market investments should be long term and strategic in nature 23

24 Where Are Frontier Markets? 24

25 Investment Issues What is an appropriate benchmark? Short answer: there isn t one; better answer: some sort of blend between the two common benchmarks Two Major Indices: MSCI Frontier Market Index has roughly 60% within the Middle East of which roughly half is within Kuwait. S&P/IFC Frontier BMI Index is more diversified. Roughly 40% of the benchmark is allocated to the Middle East. South & Central America comprises roughly 25% of the index Of the two indices, the MSCI index is the more investable index Of the managers we reviewed, the majority use some sort of blended benchmark 25

26 Index Breakdown Source: Acadian, S&P, & MSCI GCC = Gulf Cooperation Council 26

27 What Are The Economics of Frontier Markets? Market Cap in Number Of Mils USD (June Population Agriculture GDP Estimated GDP in Mils IsoCountryName Companies 2013) MktCap/GDP (%) Below Poverty (%) Unemployment (%) (% of Labor) Growth (2013) USD (2010) Argentina 84 37, % ,698 Bahrain 44 22, % NA ,100 Bangladesh , % ,143 Botswana 24 5, % ,262 Bulgaria 178 5, % ,446 Colombia , % ,418 Croatia , % (0.2) 60,109 Cyprus 121 5, % NA (2.4) 23,006 Ecuador 8 3, % ,037 Estonia 18 2, % ,150 Ghana 26 5, % ,715 Ivory Coast 37 8, % 42.0 NA ,339 Jamaica 46 4, % ,477 Jordan , % ,076 Kazakhstan 36 48, % ,143 Kenya 61 22, % ,481 Kuwait , % NA ,438 Latvia 30 1, % NA ,115 Lebanon 11 5, % 28.0 NA ,842 Lithuania 33 4, % ,894 Mauritius 83 8, % ,121 Namibia 10 3, % ,868 Nigeria , % ,725 Oman , % NA ,788 Pakistan , % ,935 Panama 12 21, % ,485 Qatar , % NA ,812 Romania , % ,970 Saudi Arabia , % NA ,617 Slovakia 53 5, % ,456 Slovenia 54 6, % (2.0) 46,692 Sri Lanka , % ,266 Trinidad and Tobago 26 15, % ,768 Tunisia 63 9, % ,489 Ukraine , % ,595 United Arab Emirates , % ,364 Vietnam , % ,952 Zambia 18 3, % ,077 Source: Acadian 5,136 1,611, %

28 Emerging Markets Equity FPL Managers as of September 30, 2013 Performance Related: Firm Name Excess Rtn - 5 Years Excess Rtn - 7 Years Std Dev - 5 Years Std Dev - 7 Years Sharpe - 5 Years Sharpe - 7 Years Info. Ratio - 5 Years Info. Ratio - 7 Years Acadian Asset Management LLC City of London Investment Management Ltd Dimensional Fund Advisors L.P Eaton Vance Management Mondrian Investment Partners Limited Neuberger Berman Polunin Capital Partners Limited MSCI EM-ND MSCI EM Small Cap-ND MSCI Frontier Markets-ND *MSCI EM-ND used for Info. Ratio calculation Market Cap Breakdown and Frontier Market Exposure: Firm Name Mkt Cap: % > 50 billion Mkt Cap: % billion Mkt Cap: % billion Mkt Cap: % billion Mkt Cap: % billion Mkt Cap: % million Mkt Cap: % < 400 million Frontier Markets Acadian Asset Management LLC 20.85% 20.12% 24.93% 27.52% 1.79% 3.70% 1.10% 0% City of London Investment Management Ltd % 17.99% 14.37% 34.46% 9.24% 6.31% 7.52% 10.9% Dimensional Fund Advisors L.P % 14.43% 19.18% 29.28% 7.71% 5.44% 6.56% 0.0% Eaton Vance Management 8.53% 24.89% 21.06% 31.65% 7.63% 3.35% 2.90% 16.9% Mondrian Investment Partners Limited 31.65% 27.20% 27.26% 13.90% 0.00% 0.00% 0.00% 1.3% Neuberger Berman 23.88% 11.03% 14.60% 34.41% 13.25% 2.59% 0.24% 1.3% Polunin Capital Partners Limited 4.19% 8.61% 6.40% 34.28% 24.29% 14.75% 7.48% 13.7% *Frontier Markets exposure is estimated using available countries in evestment Alliance 28

29 Summary Consistent with our recommendations regarding GTAA managers, we believe that giving talented managers more tools increases the opportunity to add value NEPC does not believe that adding the ability for emerging markets managers to invest in small cap and frontier markets, within reason, dramatically increases the risk level of the investment In fact, the majority of our recommended managers incorporate some degree of small cap and frontier market exposure without incurring a dramatically higher volatility level Therefore, NEPC supports allowing managers the additional flexibility to invest in small cap and frontier markets within reason 29