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In a 1991 paper (Investor Diversification and International Equity Markets), famed finance professor Kenneth French and James Poterba claimed that equity bias toward home nations “appears to be the result of investor choices, rather than institutional constraints.” This puzzle—why institutional investors stayed close to home—was then listed in a turn-of-the-millennium Kenneth Rogoff and Maurice Obstfeld paper entitled The Six Major Puzzles in International Macroeconomics: Is There a Common Cause? Academics, it seems, don’t believe that institutional investors face real inhibitors to moving capital abroad. The aiCIO inaugural Survey of Asset & Geographical Allocations (SAGA) shows something slightly different.
This survey goes beyond investor preference in a vacuum, and toward non-market based inhibitors—government laws and investment board policies. While French and Poterba may be correct that the root of equity portfolio biases extends further than such quotidian constraints, this does not mean that such constraints do not exist. For equities, as well as for other asset classes and geographies, they do—more so with boards than with governments, our survey shows, and generally more so in the United Kingdom and Asia-Pacific regions than elsewhere—and removing them would go a fair way toward a more theoretically pure allocation among the world’s largest asset owners.
A quick read of the survey results show that, despite constraints, these are sophisticated investors with sophisticated portfolios: On average, our respondents have aggressive portfolios of almost 48% equities, 31% fixed-income, and 21% alternatives, not including real assets at 9%. (Note: because of the averaging process, the figures will not add to 100%) The average return for the past year was 10.5%, with United Kingdom funds recording the highest average of any region.
At a 30,000-foot level, funds located in smaller markets are more likely to invest outside those markets, for obvious reason and with suggestive results. On average, nearly 50% of equities and 69% of fixed-income investments are of the home market variety. Interestingly, the United Kingdom—which had the highest average return—was the least likely to invest in home-country equities (only 10% of their equity holdings are in the UK market).
Lowering the altitude of observation, however, indicates disparities across region and asset class regarding non-market based restrictions—which we classify as either governmental laws or investment board policy. National or local laws are much less restrictive than board policies, with regard to geographical allocation, the survey shows: Only 8.3% of respondents say that they are limited by such laws, with North America the least restrictive (4.5%, although when broken out, Canada has a much higher level of 33%) followed by Europe (11.1%). Asia-Pacific—which, anecdotally, has more laws limiting foreign or domestic ownership—has a much higher percentage of funds facing such restrictions (40%). With regard to asset allocation, 12.9% of funds surveyed face restrictions in what they can and cannot invest in, with North America being less restrictive than other areas.
Investment board policy is more restrictive, on average. Twenty-nine percent of respondents claim they are limited by such constraints from investing a certain percentage or absolute amount in a specific region or company. Unlike with legal regimes, however, less of a percentage of European funds claimed such restrictions compared with North America, the United Kingdom, or the Asia-Pacific region. With asset classes, however, boards are on average less restrictive: Only 26% of respondents claimed they were restricted vis-a-vis asset classes, with European and United Kingdom funds claiming more freedom than their North American counterparts.
If these restrictions were lifted, only a moderate change in allocations would occur, for more than 50% of respondents strongly agree or agree with the statement that lifting restrictions would cause no change in allocations. The result of any change would be varied, however. Only 16% of funds claim that their risk appetite would increase; 8% claim that their risk appetite would actually decrease. Diversification would increase in 27% of funds, and 23% believe their provider/manager universe would expand. Most importantly, 24% believe they’d see better returns (although, oddly, 10% think their returns would decline).
If such policies were rescinded, emerging markets would be a major beneficiary. Nearly 55% of respondents say that they strongly agree or agree that their emerging market exposure would increase in such circumstances. Alongside this, however— likely because of the limited scope of investment opportunities in emerging markets—home-country economies would suffer little, with only 16% saying that a shift away from their current allocation would harm the local economy.
Overall, from a theoretical point of view, the survey’s results are encouraging. Non-market constraints exist, the survey shows, but they are relatively infrequent. There is always a concern, of course, that an economic crisis will act as a catalyst for protectionism and nationalism, in investment policies as much as any other sector of national concern. However, this survey is simply a snapshot. Whether asset owners worldwide have avoided any trend toward increased restraints will only be revealed in SAGA’s second iteration.