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.

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