SWFs wary of hidden emerging market exposure
, March 26, 2014
By Natsuko Waki
Sovereign wealth funds (SWFs) see emerging market turbulence as a long term buying opportunity, but are wary of excessive exposure via some of their Western holdings such as luxury goods makers, a top investment official at Franklin Templeton said.
David Smart, who heads a team managing around $85 billion for sovereign funds and supranational clients at Templeton, said the $5 trillion sector can afford to ride out volatile swings thanks to its long-term horizons.
"In terms of our client base, we haven't seen any evidence of de-risking. If anything we've seen willingness to take advantage of opportunities. They have the ability to withstand volatility," Smart told Reuters in an interview on Tuesday.
"They see it as a long-term acquisition opportunity."
But the funds, which manage windfall oil revenues for future generations, are shifting their approach to emerging markets, having treated them as a one homogenous group for many years.
They are now reframing allocation with a focus on how much of their holdings are truly exposed to the emerging world in underlying economic, not just geographic, terms.
One way to do so, Smart said, is to use measures such as index provider MSCI's Economic Exposure Index.
The index provides a measure of companies' economic exposure - sensitivity of a firm's performance to economies in which it operates - using the geographic distribution of its revenues, regardless of where it is based.
"A number of them are looking at (the index). There's a great deal of awareness about it ... I'm not being negative on emerging markets but it's merely a degree of risk factor awareness," he said.
For example, having too many European companies which sell a lot of products in emerging economies would push up a fund's overall economic exposure to emerging markets.
Luxury goods, car manufacturers and pharmaceuticals are the three sectors which derive a higher proportion of revenues in developing countries, Smart added.
For example, luxury fashion brand Christian Dior is listed in France but at least 40 percent of its revenues come from emerging economies.
"Our approach is to be cognisant of the fact that you already have, on the MSCI developed index basis, some 21-22 percent of exposure to EM in economic terms," he said.
"You can make sure you are not double allocating to EM."
MSCI Economic Exposure Index for Europe, which measures economic exposure of European companies to emerging markets, has fallen 3.6 percent this year, compared with a broad European gauge which is flat.
An anti-corruption drive in China and a general economic slowdown in other emerging markets have dented sales of luxury goods from high-end watches to the logo-printed products sold by the likes of Louis Vuitton or Gucci.
LIQUIDITY VS RETURNS
Smart, whose clients include central banks, said currency reserve management was becoming more divergent, with one group pursuing liquidity to be ready to intervene in local markets and the other trying to achieve their return target, typically of about 3-4 percent plus inflation.
Data earlier this month raised eyebrows as foreign central banks' overall holdings of U.S. Treasury debt fell by $104.5 billion to $2.855 trillion in the week ended March 12.
That underscored the appetite of central banks such as Russia and Turkey to liquidate their Treasury holdings to supplement their decreasing foreign reserves and help support local currencies.
And others may also be tempted to keep liquid investments such as Treasuries as contingency.
"If you need to intervene to the tune of $10-20 billion to stabilise your currencies, it's really Treasuries and gilts that offer instantaneous liquidity," Smart said.
"But there's a big carry cost to having cash. A lot of my clients ask about how to hedge inflation risks on a 5-10 year horizon. Inflation is a nasty scenario for all developed market government bonds." - Reuters