OREANDA-NEWS. June 10, 2015. Aon Hewitt, the global talent, retirement and health solutions business of Aon plc (NYSE:AON), has advised pension schemes to reconsider their asset allocation approach and to increase their allocations to emerging market equities on an actively managed basis.

Over the last five years, based on MSCI indices, emerging markets have underperformed by around 50% in comparison with developed markets, resulting in a loss of faith and net capital outflows. Over the last three quarters these outflows have been larger than those during the 2008/2009 financial crisis.
However, in a recent client webinar attended by over 130 representatives from UK pension schemes, Aon Hewitt reviewed the outlook for emerging market economies and urged pension schemes to consider increasing their allocations to up to double current market capitalisation weightings. It highlighted the differences in fundamentals and returns of BRIC and non-BRIC countries, where the latter have included some of the strongest performing economies in the world over the last decade, and argued that the case for not treating emerging markets as a homogeneous asset class continues to grow stronger.

A poll of the webinar attendees found that 40% of the participants plan to increase their allocations to emerging equities over the next 12 months, while 35% of them will maintain their current allocation. Only 10% of the respondents said that they will decrease their exposure to emerging market equities.

Zoe Taylor, principal at Aon Hewitt said:
“Emerging market equity fundamentals are improving. Emerging economies are expected to outpace the developed world in economic growth terms by an expanding margin, while corporate profits are also expected to improve with lower oil prices driving profit margins higher. There are also substantial differences in the relative ‘cheapness’ of countries within the emerging world, but this reinforces the need to examine them more closely and to be selective given the high degrees of differentiation between countries.

“With this positive outlook, we believe that many schemes should be considering increasing their allocations.   While recommendations are very client specific – they are driven by different objectives and beliefs and existing indirect exposures - we can see some clients now reaching up to two times market capitalisation weightings.”

Zoe Taylor continued:
“There are a number of ways to access this opportunity, but if a scheme has strong governance structures and is able to monitor managers, we recommend implementing an active approach to capitalise on the changing dynamics within this diverse universe. Wider valuation spreads compared with the developed world should provide active emerging market managers with an abundance of stock-picking opportunities.
“For schemes which don’t have this kind of set-up, the simplest path is through a passive emerging markets index tracking fund, providing broad exposure across a variety of countries. However, given the ever increasing differentiation across these markets, there are some obvious limitations. Alternatively, schemes can delegate a portion of a mandate to a third party which can access a number of best-in-breed active managers, allowing schemes to access a wider opportunity set without spending so much time on governance and monitoring.”