A Reader Asked

“I would like your opinion re: the largest pension funds in the U.S. changing their asset allocation reducing their U.S. equities significantly.  Are foreign and emerging markets going to reap thew benefits of this?”

Our Response

Calpers and several other large state institutions have been considering or are in the process of reducing their domestic equity exposures from the 40% range to perhaps as little as 20%.  They do intend to increase their foreign investments/allocations with the proceeds.

I have come to learn that in the short run, fund flows can do huge things for the performance of certain segments and styles within the market.  And while I do think that emerging markets are going to offer areas of growth independent of our economic cycle, I also tend to believe that we are much more connected to one another than many folks have come to believe.  As I wrote in our update Engines and Brakes, the U.S. may no longer be the engine that drives the world economy, but its brakes are still likely powerful enough to slow it.  People that say “it’s different this time” may be fooling themselves.

So the answer is two fold.  Yes, a reallocation of fund flows will affect prices, although given how huge the markets are it is uncertain whether or a small handful of even large institutions can have a major impact even in the short run.  The second point is that the timing of these changes might be a little suspicious.  The major beneficiaries of emerging markets growth have been commodities, materials and energy sectors.  All are at peak prices.  There may be a bubble about to pop and as is always the case, the biggest flows often mark the peaks.  Institutions aren’t immune to whiplash.  I would also suspect that many emerging markets have done well because they are natural resource rich.  As their consumers increase their standard of living, they will likely seek out higher end finished goods and services, where the U.S. excels.  (Just at a time when our dollar also makes such goods more affordable.) 

We’re, as a result, being a little more cautious on foreign investments, believing that growth is likely to slow worldwide, not just domestically.  We still think investors should have a healthy allocation to the space, but I don’t think I’d want to double it, which is what a 20% swing would do for us.  Again, this suggests to us a resurgence in U.S. growth ideas, where innovation and productivity are key elements that determine further gains and upward moves in valuations.

I would also point out that it is quite interesting that oil money from places like Abu Dhabi and elsewhere might be increasingly finding investment opportunities attractive here in the states just as our funds are moving elsewhere.  Many Canadians, I read last night, are already coming  to the U.S. in larger numbers to shop due to parity in our currencies.  It just goes to show for every yin there is a yang.  I guess I’m more of a yang fan at this point in time.