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Emerging Market Asset Allocation: "The World Is Upside Down"
Most institutional portfolios are underweight emerging market assets and those with higher allocations have primarily relied on emerging market equity strategies for the bulk of returns.  Both of these decisions have left investors with sub-optimal performance during a period of extraordinary emerging market returns.  In the last decade, emerging market economies have undergone a remarkable transformation and emerging market assets have provided returns in excess of developed market assets in both absolute and risk adjusted terms.  The Rohatyn Group ("TRG") believes the emerging market transformation is anchored by powerful economic, political, and demographic shifts of a tectonic nature, a transformation difficult to reverse.
TRG believes emerging market allocations should be targeted at 20%-30% in the short to medium term and probably higher beyond that, yet most institutions remain considerably underweight this opportunity.  Taken as a whole, emerging market equities, bonds, and currencies have a total market capitalization in excess of $22 trillion with daily trading volumes approaching $200 billion.  While emerging market equities are the natural and most popular vehicle used by investors to gain exposure to the emerging market growth story, other lesser understood assets, such as currencies, local bonds, corporate bonds, and even inflation “linkers,” offer very attractive risk/return and diversification opportunities.
The key question for investors is how to access the financial returns from emerging market economic growth.  TRG proposes a multi-asset approach that overcomes both traditional allocation concerns and single asset class volatility that have confronted investors.  Starting with a sample developed market portfolio of stocks, bonds and commodities, TRG quantifies the benefit (in terms of information ratio) and tracking errors obtained by allocating varying amounts to each and all of the emerging market assets under consideration.  TRG also introduces the concept of the unified emerging market asset for "one-stop shopping" based on equal risk across the various market opportunities.  A simple “buy and hold” strategy of this unified asset is shown to have a high and stable information ratio, as well as low correlation to a sample developed market portfolio.  Increasing the holdings of emerging market assets (other than equities) and an overall much larger emerging market allocation greatly enhances the portfolio analysis in this exercise.
TRG's attached white paper is divided into three sections: Part I: The Fundamentals; Part II: The Markets; and Part III: Asset Allocation. Each section can be read on a stand-alone basis, or in its entirety as an overall compelling story.  Please let us know if you have comments or questions.
TRG Management LP280 Park Avenue, 27th Floor New York, NY 10017 +1 (212) 984-2900
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