Friday, October 30, 2009

More International Equity?

A question posed by fiduciary investors today is whether they should increase their allocation to International Equity. The answer depends on whether their intention is to chase international performance or to adjust their long term strategic exposure to international equity?

A neutral global market capitalization weighted investment benchmark would allocate about 50% of equity to international. Academic studies and industry practice suggest there is diminishing value from international allocations beyond 40% of equity. A 20% international allocation of total equity is often considered a minimum prudent allocation. Many plan fiduciaries discount back from a strategic 40% exposure for the following reasons:

1) global market return correlations have been going higher thereby reducing the diversifying value of int’l equity,
2) pension plan liabilities are often denominated in US $’s making foreign denominated assets more volatile relative to liabilities,
3) foreign investments costs more than domestic investments, and
4) comparability with similar pension plan allocations.

Many investors are tactically overweighting international equity due to the weakening dollar and perceived lower valuations. Long term institutional strategies presume currency effects tend to cancel out over time and that valuations tend to mean revert. Using currency or valuation to support changes in international equity is tactical and implies performance chasing rather than strategic alteration.

Wednesday, October 28, 2009

Senate Committee Review of Target Date Funds

The Senate Special Committee on Aging held another fact finding session on Target Retirement Funds (TRF), concerned by their lack of transparency, high fees and and potential conflicts of interest. Testimony (available via webcast) provided by a range of regulators and private fund providers was similar to what has been presented in the past.

The Q&A portion was of particular interest in that it addressed arguments on both sides of proprietery fund management and whether conflicts of interest inherent in proprietary target date funds, but not addressed by ERISA due to an exemption, are adequately covered by securities regulations as intended by Congress when drafting ERISA. Other points of interest raised during the prepared comments:
  • SEC will be focusing on the use of dates in fund names, whether TRF sales material requirements provide sufficient information and balance and investor education.
  • EBSA is looking at QDIA regs to see if more specific guidelines are necessary to help plan fiduciaries better understand, select and monitor TRF's. In the Q&A it sounded like DOL will give additional consideration to the use of more conservative funds as QDIA.
  • Morningstar was concerned about the range of fee, the issue of proprietery fund management which would not be considered institutional investing best practice, and the low level of conviction managers have in these funds as indicated by their very low personal investments in them. 57% of TRF managers have no investment in them.
  • Fidelity made some important and often overlooked points about the intrinsic value of these products for uninvolved investors. They also indicated support for a number of recommended communication initiatives. A later point about investors desires to have a company and brand they are comfortable with manage the totality of their investments was well made. Having a good product is only half the battle, getting plan particpants to select the product is just as important and brand plays a big role in that decision. Plan fiduciaries must also consider that aspect when selecting a TRF for their plan.
  • A private TRF provider pointed out the inconsistency of DOL's rethink of the investment advice rules because of conflicts of interest while allowing proprietary funds to be used within a TRF product because they are not considered plan assets under ERISA. A point made here was that requirements & remedies are available under securities laws to address these issues.

  • The Committee members seemed to appreciate the difficulty in trying to legislate investment results in this area.