The Dallas Police and Fire Pension Fund (DPFP) is implementing emerging markets debt into its $2.2 billion portfolio for the first time after its consultant Meketa Investment Group had recommended the benefits of the typically high-risk, high-reward asset class during the pension’s latest investment committee meeting.
Allocations to emerging markets debt have been on the rise within public pension plans, given their seasoned utility in gaining exposure to fast-growing, increasingly creditworthy emerging market countries and companies, providing an attractive return/risk opportunity.
Meketa highlighted several benefits to the inclusion of emerging markets debt to the public pension plan’s portfolio, noting that different regions perform better (or worse) at different times, meaning combining them in a portfolio allows investors to benefit from the assets’ different behaviors and reduce risk.
The consultant also noted that emerging markets have a lower starting point of economic activity and favorable demographics. Younger and larger populations have the capability to import sophisticated technology from developed nations and have it distributed throughout their markets, potentially leading to substantial economic benefits and large GDP increases over the coming decades.
Additionally, Meketa pointed out that currently, currency emerging markets debt offers more than a 3% yield advantage relative to US Barclays Aggregate. Emerging markets comprise roughly 80% of the world’s population and approximately 40% of economic output, however, the emerging markets debt market is expected to grow from $24 trillion to nearly $40 trillion over the next five years.
Emerging market economics include much of Africa, Eastern Europe, Latin America, Russia, the Middle East, and Asia (excluding Japan).
Despite intrinsic risks to emerging markets debt investments, such as political risks, potentially volatile returns, higher transaction costs, and currency volatility, Meketa implored the DPFP to carry out its newly-minted 4% target allocation to the asset class in its $2.2 billion portfolio. A 4% allocation would amount to approximately $88 million.
“Given the long-term return expectations for the asset class, current yields, and the diversification benefits, we continue to have conviction in emerging markets debt as a strategic part of the portfolio,” Meketa said in a report to the pension.