Institutional investors are continuing to bias their equity portfolios towards developed economies, unnecessarily retaining higher levels of risk and limiting returns, according to Mercer.
Developed economies feature structural disadvantages such as excessive public debt and weak bank lending, while many developing markets benefit from young and expanding populations with strong growth.
Mercer has released a paper titled A Blueprint for Improving Equity Portfolios in which it calls on institutional investors to carry out a fundamental review of their equity portfolios.
Nick White, principal in Mercer’s Investment Consulting business, said the growth of developing countries was less interrupted by the global financial crisis, while increased regulation and the potential for policy errors are likely to slow growth in the developed world.
“Investors should ensure they have access to broad equity market returns. The problem is that many equity strategies are biased in favour of developed countries and also large cap stocks, and this is likely to increase fundamental risk and may compromise returns,” White said.
“Investors need to ensure their equity portfolios are sufficiently diversified with exposure to as many forms of risk premia as possible. This will ensure their portfolio will be more resilient in the face of any unforeseen market dislocation,” he said.
Mercer recommended diversifying away from large cap developed markets in a rational way with increased exposure to emerging, small cap and low volatility strategies, in order to preserve performance potential and to improve the efficiency of portfolios.
Although Australian clients’ home bias provides an indirect exposure to the emerging markets it is in clients’ best interests to increase their direct exposure to the emerging markets to ensure they capitalise on the emerging markets story, White said.
