NOTE: Free essay sample provided on this page should be used for references or sample purposes only. The sample essay is available to anyone, so any direct quoting without mentioning the source will be considered plagiarism by schools, colleges and universities that use plagiarism detection software. To get a completely brand-new, plagiarism-free essay, please use our essay writing service.
One click instant price quote
... isk of encouraging irresponsible behavior is present. In any event, the likelihood of a government 'bail-out in extreme circumstances suggests that regulatory oversight is desirable. Investing in Emerging Markets? The growing institutionalization of savings, driven in large part by population ageing and pension reform in the OECD countries, has provided an important stimulus for sustained flows of private capital to emerging markets. The scale of flows in the 1990 s from the 'older OECD area to the 'younger emerging markets and the broadening of market access confirms the increasingly rapid integration of the worlds financial markets.
In 1996, for example, net flows of private capital grew by 22 % over the previous year, to a record figure of $ 235 billion. Since efforts to liberalize cross-border financial flows are continuing, as also to develop and to strengthen capital markets in the countries receiving these flows, this trend is likely to persist as OECD pension funds and other large institutional investors increase their exposure to emerging markets and diversify their portfolios more widely. At the moment, only a relatively small portion of pension-fund assets in OECD countries is invested overseas. Among G 10 countries, for example, only pension funds in Belgium, the Netherlands and the United Kingdom hold foreign assets on any scale, of which just a small part is invested in emerging markets. In those G 10 countries with substantial pension-fund holdings (Belgium, Ireland, Japan, Netherlands, Switzerland, United Kingdom, United States), the share of foreign assets increased from 12 % in 1990 to 17 % in 1996. Surveys suggest that US pension funds and mutual funds currently have about 2 % of their assets invested in emerging markets.
The figure for UK pension funds and mutual funds is somewhat higher (3 - 4 %). Japanese and continental European institutional investors have negligible emerging-market assets in their portfolios. All the evidence points to the fact that all types of institutional investors are much less internationally diversified than the world market portfolio, where countries would be weighted in proportion to the importance of their financial markets in the world economy. Pension-fund portfolios in particular display a strong domestic bias.
On the other hand, the trend of investing in foreign markets is supported by the growing influence of the fund-management industry, which is leading to a more professional attitude towards international fund allocations. The ageing of OECD populations and the resulting growth of pension-fund and other institutional assets have increased the demand for the services of professional fund-managers, whose investment and trading strategies in turn have a considerable influence on the operational aspects of financial institutions and markets. And a central strategic feature of pension investment is portfolio diversification. The Pros and Cons of Diversification Diversification aims; to improve the ratio of risk to return, and a number of studies indicate that international diversification brings particular benefits. (For example, S.
Heston and G. Rouwenhorst ('Does Industrial Structure Explain the Benefits of International Diversification? , Journal of Financial Economics, August 1994) found that diversifying across countries, but staying within a single industry, reduces volatility more than diversifying across industries in a single country, even though both portfolios carry the same average return). Arguments based on demographic trends have been advanced to suggest why, in principle, it would be beneficial for OECD pension funds to invest in the younger, non-OECD economies. But there are risks and costs in this strategy. A number of factors (including investment-risk related to poor financial infrastructure, political risk, the impact of capital exports on OECD security prices, financial fragility in emerging markets) reduce the potential benefits.
To some extent, these concerns can be addressed by investing in securities issued by multinational companies or through the use of swaps and other derivative securities. Indeed, the development of global markets for swaps and derivatives makes possible the linking of diverse national systems to exploit new opportunities for the efficient international transfer of risks as well as resources. In this way, countries can retain the capital resources invested by their own pension funds, and yet gain the benefits of international pooling of risks through such devices as international equity swaps. But a closer look at stock-market returns and equity risk in emerging equity markets gives grounds for caution.
Although in 1985 - 95 the industrialised countries have tended to grow more slowly than the developing or emerging economies, this pattern has not been uniformly reflected in stock-market returns. In that time, indeed, the G 7 stock markets have given better returns than the emerging markets: the 'Standard and Poor 500 equity index has produced better returns per month than the average of all the emerging market indices. The same is true of the lag five years. Naturally, the future might bring better news in higher expected returns and / or lower risks, especially in the light of the expected ageing-induced pressures on financial returns in the OECD area and further improvements in the financial infrastructure in the emerging securities markets, as well as further development of their domestic institutional investors.
Diminishing Returns from Integration By exploiting the fact that risks and returns on assets are not perfectly correlated, a portfolio with international assets can achieve more stability in returns without sacrificing the return overall. This insight has resulted in the adoption of asset-allocation rules based on international diversification. But more recent analyses have pointed out that the benefits of diversification are decreasing: growing financial integration is leading to an increase in correlation of returns in particular on the bond markets and especially in those of western European thus circumscribing the potential for reducing risk on a bond portfolio through diversification. Moreover, the fact that an increasing amount of institutional money is managed using diversification is bringing diminishing rewards.
The high correlation of returns between countries has in some cases led to a restructuring of portfolios by diversifying by sectors. The correlation between OECD stock markets and equity markets in emerging countries has likewise increased and, therefore, the risk-reducing benefits of international investments have become less powerful. They can nonetheless still be enjoyed, also during sharp downside moves of securities markets. Although the expectation is that the trend of investing in emerging markets by pension funds will continue, abrupt loss of access by individual countries to the global capital market will probably still occur: there are the recent examples of Mexico in 1994 - 95 and several South-East Asian countries in 1997 - 98. This cyclical variability in capital flows can be ascribed to two main factors: divergent macro-economic conditions in capital-exporting and -importing countries, and crises in individual recipient countries Uncertainties about the sustainability of macro-economic policies and weaknesses in the financial infrastructure increase the risk that the currency of the capital-importing country will be 'tested through a sustained attack, leading to a sudden drying-up of capital inflows and major capital outflows. (Private-sector capital flow to emerging markets fell from $ 295. 2 billion in 1996 to $ 199. 6 billion in 1997 -a figure entirely accounted for by the five Asian countries bit hardest by the recent crisis (Indonesia, Korea, Malaysia, the Philippines and Thailand) which suffered in 1997 a net outflow of $ 12 billion, compared to a net inflow of $ 93 billion in 1996). Indeed, financial integration, driven by population ageing and other structural factors, has also increased the potential intensity and duration of such periods of financial-market turbulence.
There is also evidence that pension funds an other institutional investors at times play a crucial role in determining asset prices in emerging financial markets, with shifts in sentiment resulting in periods of bubble-like booms and busts and highly volatile financial markets. Recent de stabilising shifts in international capital flows have drawn attention to the following areas where urgent policy-actions in emerging markets are required to prevent future currency crises and 'contagion effects: strengthening of the financial infrastructure, including regulation and supervision consistency between the exchange-rate regime and macro-economic and financial policies 3 implementation of better, internationally acceptable risk-management standards and practices by pension hinds and other institutional investors developing and applying high standards of accounting, transparency and financial reporting an improvement in disclosure standards so as to reduce uncertainties for international and domestic investors. The implementation of these structural reforms is essential for making investing OECD retirement funds in non-OECD countries more attractive. The development of advance-funded pension systems should go hand-in-hand with a strengthening of the financial market infrastructure, including the establishment of a modern and effective regulatory framework. The productive, safe investment of retirement savings requires well-functioning capital markets. The supporting infrastructure involves legislation and codes of conduct, internationally acceptable accounting standards and disclosure rules, proper pension-asset investment rules and co-ordination among the different regulatory and supervisory agencies involved in the provision of retirement income.
A competitive mutual-funds and asset-management industry is required to minimize the costs of managing retirement assets. All of these elements have to reflect the realities of the new financial landscape. Emerging market economies should implement radical structural reforms not least of their financial markets so as to make the investing of OECD retirement funds in non-OECD countries more attractive. Bibliography: Ambachtsheer, K. , Capable, R. (1998, December). Improving pension fund performance. Financial Analysts Journal. 15 - 6.
Barreto, S... (1999, March, 22). Plan structure changes could be on horizon. Cranes Cleveland Business. 18. Institutional Investors. (1997). Statistical Yearbook. Feinberg, P... (1999, January, 25).
Corporate funds get smaller: many public and union pension gained assets, but big corporate plans lost value in the year ended sept. 30. Pensions&Investments. 3 - 5. Fitchett, J... (1998, October, 3). U. S.
pension funds unnerve French. International Herald Tribune. 24 - 25. Kelly, B... (1999, January, 25). Pension founds show strong returns: good, but not dazzling, performance doesnt match the highs of 1997. Pensions&Investments. 20.
Kelly, B... (1998, August, 24). 300 biggest funds grew by 16 % last year. Pensions&Investments. 14 - 15. Kessler, C... (1996, December). Diversification - Is still alive? .
Economic and Financial Prospects, 6, Swiss Bank Corporation. Pool, R... (1999, March, 19). Pension funds. New Statesman. Private Pension System: Regulatory Policies, 1998.
Free research essays on topics related to: mutual funds, emerging markets, capital flows, financial markets, macro economic
Research essay sample on Pension Founds And Financial Market
