Summer 2008

Going global, again: DC plans should embrace a less U.S.-centric approach

Submitted by: Capital Guardian Trust Company

Most defined contribution participants have minimal exposure to non-U.S. investments and are not able to benefit from the long-term growth of some of the world's most dynamic companies and industries. Just as defined benefit plans did in the 1990s, defined contribution plans should move away from a largely U.S.-centric investment view. Plan sponsors can encourage this by providing global and "all-country" equity options in their DC lineups. According to Pamela Hess, defined contribution practice leader for Hewitt, "There is a growing awareness that markets are global and investing should go beyond the U.S." Even better would be to encourage global equity options instead of a mix of domestic and international portfolios, as true global portfolios can provide better results than combining separate U.S. and non-U.S. components.

Missing out

Most defined contribution participants have minimal exposure to investments outside the U.S. Despite the majority of equity market capitalization being outside the U.S. - and a growing comfort level among participants to invest there - the average participant allocation to non-U.S. equities is only 9%, according to Callan Associates.1 That is out of line with the size of these markets and the opportunities they represent. Stocks outside the U.S. represent 53% of the MSCI World Index and 58% of the MSCI All Country Index, which includes emerging markets.2

In most cases the participant's income and other forms of investment, such as real estate, are also likely to be dollar-denominated investments, resulting in a highly U.S.-centric base of assets. With regard to equities, that has been to their detriment over the past decade. U.S. stocks have provided an annualized return of 5.9%, compared to 8.9% for non-U.S. stocks and 14.3% for emerging markets stocks.3

Benefits of broader opportunities

Professional investors, on the other hand, are more aware of the benefits of a broader investment universe. While the U.S. is a leader in many areas, non-U.S. stocks have provided the best opportunities over the past 10 years in diverse industries such as chemicals, metals and mining, industrial conglomerates, luxury goods, health care equipment, financial services and telecommunications.

From an economic perspective as well, opportunities outside the U.S. are rapidly expanding. While the largest economy in the world, the U.S. is still only about a fifth of the global economy. Global portfolios can tap into a large part of the wealth creation taking place outside U.S. borders. (This is especially true if emerging markets are added to the mix.)

Professionally managed defined benefit plans allocate 17% to non-U.S. equities, and many are considering increases through global mandates.4 That is in the context of an even broader set of allocation options, including hedge funds and private equity. These institutional investors "went global" in the 1990s and are continuing to do so.

Encouraging the shift

Nearly all DC plans now offer a non-U.S. equity option. But it is often a single option, competing with multiple U.S. equity choices. A stepped up educational effort could be part of the solution, but we think a global equity option would also go a long way toward encouraging this shift.

According to Callan Associates, only 8.5% of DC plans have a global equity option.1 When a global portfolio is made available, the average participant allocation to it is 8.7%.1

There's going global, and there's going global

A global equity option alongside U.S. and non-U.S. options would very likely increase participant exposure to non-U.S. markets. Ideally, global equities should be presented as preferable in some ways to a combination of U.S. and non-U.S. portfolios. A truly global mandate seeks out the most attractive investment opportunities, regardless of geography, on a real-time and flexible basis. Managers that have been given a broad global mandate and can choose companies from a wider universe assemble a portfolio of "best of world" companies, which will differ from a portfolio that combines "best of region" with another "best of region."

For example, a manager might consider Siemens to be the best industrial company in the world, even though that manager may view General Electric as the best industrial company in the U.S. A truly global portfolio, therefore, might have a large position in Siemens, whereas the bolted together portfolio might have a smaller position in each company.

Being able to invest in the highest investment conviction on a global basis is powerful; it should lead to better results than a patchwork of U.S. and non-U.S. portfolios. At Capital Guardian, this is borne out with our own results, which are consistently better for global equities than with a hypothetical combination of U.S. and non-U.S. equities (based on the weightings in the MSCI World Index). The stocks in our global portfolios represent our strongest investment convictions on a global basis. The weight of different regions, countries and industries in the portfolio are the result of forward-looking decisions rather than index weightings that are based on the past.

Investing in a global portfolio also mitigates the likelihood of participants chasing returns between U.S. and non-U.S. markets, and getting burned by the cyclicality. Instead you have professional judgment shaping the allocation based on a global perspective, rather than a U.S.-centric one.

Helping participants

Adding a global equity option to a DC plan fills a void and makes good investment sense. It should result in participants having a more appropriate level of exposure to equities outside the U.S that is more in line with how professional investors allocate assets. We believe most participants will be comfortable with greater non-U.S. exposure. All they need are attractive global equity options in their plan, and perhaps a little nudge.