This joint research was undertaken by GIC’s Total Portfolio Strategy division (TPS) and PIMCO.
The TPS division of GIC’s Economics & Investment Strategy department (EIS) works closely with GIC’s Group Executive Committee to set the Total Portfolio’s strategic asset allocation, define factor and asset class opportunity sets and benchmarks, and target optimal internal active strategy exposure.
This collaboration was done in commemoration of GIC’s 40th anniversary and PIMCO’s 50th anniversary, in 2021.
The Emerging Markets (EMs) have not only emerged as key engines of global growth and political influence, their openness to foreign investment, and the depth and breadth of their capital markets have also grown tremendously over time. Yet, portfolio allocations to EMs have been hindered by perceived concerns about macro-economic and political risks, corporate governance, and market accessibility limitations. Today, given lower prospective developed market returns due to low interest rates and high valuations, the case to diversify portfolios to EMs has never been stronger, especially when considering their higher market volatility and hence mispricing opportunities.
In this paper, GIC and PIMCO present an intuitive, flexible and practical asset allocation framework to build a multi-asset, regionally balanced emerging markets portfolio. This framework deviates from traditional cap-weighted benchmark approach and anchors on a more deliberate, risk-balanced allocation between asset classes and regions. On top of this, it incorporates the ability to systematically factor in investors’ risk budgets and apply valuation-based return signals to over-weight more attractive countries and assets and under-weight the less attractive ones, exploiting mis-pricing and large dispersion among EM markets. Resultant portfolios from this framework reflect higher risk-adjusted returns, with not only shallower drawdowns but also better diversification benefits, as measured by their performance relative to a 60% equities /40% bonds Developed Markets (DM) portfolio.
We believe that this new portfolio construction approach can help signal a more optimal allocation to the EMs and hence deliver more resilient returns for investors over the long term.