How Organizations Can Get the Most Out of Equities

Institutions such as endowments should view equity allocations through geographic, strategic and home-country-bias lenses.


Students are pictured on the campus of Yale University in New Haven, Connecticut on Tuesday, June 10, 2003. About 26 percent of the university’s $10.7 billion endowment is in hedge funds, about five times the average among U.S. colleges. Photographer: George Ruhe/Bloomberg News


Given the decoupling of the global equity markets over the past several years — and the notable outperformance of the U.S. markets — many institutions have started to reexamine their equity allocation to ensure they are taking the current economic environment into full account.

Though there is no definitive multidimensional framework for strategic allocation that incorporates all quantitative and qualitative factors, we at J.P. Morgan Asset Management believe it’s wise to focus on three key factors: geography, execution strategy characteristics and home-country biases.

Geography is a key ingredient in an allocation mix. Yet wide dispersion in geographic performance is the norm. Variables such as the size of a country’s economy, historical growth rates and the growth dynamics of local industry and companies are no guarantee for public market investors. Return dispersions among individual country market performances can be extreme in any given year. In 2014, U.S. equity markets gained 13.7 percent while Brazil fell by the same amount. One year does not validate or invalidate a strategic allocation. It can be very challenging for investors nonetheless to live through protracted regional underperformance, waiting for the perceived fundamentals to emerge. A tactical allocation may help smooth the path of relative performance during a year like 2014. For reliable returns, it’s best to build a portfolio around present market conditions, specific regional and country anomalies, forward-looking assumptions and an appropriate risk profile.

Investors must also carefully consider equity risk levels. Over the past few years, the volatility in global and U.S. equity markets has demonstrated the need to manage equity risk over the course of a full market cycle.

The strategies used can substantially alter the risk and market-beating potential of equity exposure. The historical reality, though, is that economic growth does not always translate to positive public market returns. Thus it is essential to examine a broader array of investment strategies to capture economic growth, manage risk and add strategies beneficial to generating potential alpha. With regard to equity absolute returns, both hedge funds and private equity strategies provide a potential measure of volatility abatement that public markets do not. In 2014, at 7 percent, hedge funds had one of the lowest volatility ratings compared with U.S. large-cap equities, at 16 percent. Keep in mind, however, that because the dispersion of returns is so wide among hedge funds, managerial due diligence is imperative.

Home-country bias is the third factor to think about in determining an appropriate equity allocation. While it can provide some modest benefits, organizations need to consider the breadth of global equity opportunities to ensure they are optimizing their overall return. Some investment committees create home-country concentrations to support local investment or because they have intimate knowledge of that region. Whatever the motivation, these investors tend to be more likely to hold equity risk through periods of uncertainty and volatility. Such commitment allows them to reap the benefits of long-term compounding — a main differentiator between investment success and failure for many investors.

There are key downsides to home-country bias, however. Industry concentrations and public capitalizations, for example, fail to capture the breadth and higher growth segments of an economy. If an investment committee has a preference for home-country bias beyond established benchmark or GDP weights, it’s important to take into account the yield implication. Specifically, how large is the home-country bias in terms of its impact versus more globally diversified benchmark metrics? The strong U.S. equity performance of the past two years notwithstanding, investors without global exposure may miss opportunities in high-growth regions such as India — a country that saw 23.9 percent equity growth in 2014.

Once an organization has taken all of these factors into consideration, it can develop a globally focused strategic equity allocation and portfolio. By balancing public market opportunity and liquidity alongside private market alpha potential and illiquidity — all while keeping an eye toward risk moderation — an organization can craft a plan to meet its long-term objectives.

Monica Issar is global head of endowments and foundations at J.P. Morgan Asset Management in New York.

See J.P. Morgan’s disclaimer.

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