This is the third in a series of five articles, written by John Morris and Nick Malaczynski, on international investment by pension funds. Morris and Malaczynski are the managing director and chief institutional consultant of TriStar International Consulting Limited, a company which provides international investment consulting services to South African retirement funds
There are no shortcuts to successful international investment.
Pension fund trustees, who decide to invest fund assets overseas, will need to engage in a disciplined international investment process to ensure that they achieve the risk reduction and performance enhancement which international investment promises.
Here is a list of some of the steps pension fund trustees should follow before investing funds overseas:
* Begin by developing a written investment policy or strategy which sets out the current position of the pension fund, where the trustees intend to take the fund, and the steps which the trustees will follow to reach their goal. This policy should not just state how the pension fund will invest, but also what risks it will not take and what investments it will not make.
* Analyse the South African investment environment and the pension fund's existing domestic portfolio. A pension fund's international portfolio will need to complement and enhance its larger domestic portfolio. It is not possible to create an appropriate international portfolio unless you understand your domestic portfolio, and what the domestic market is giving the pension fund in terms of both risk and return.
* Analyse international markets and the investments available in those markets. There is no point investing overseas in markets which perform the same as the South African market, or in markets which will not reduce the overall risks of your portfolio. It is also essential to consider overseas industries and market sectors - not merely overseas countries. One of the reasons to invest overseas is to get exposure to industries and sectors which are not well represented in the South African market.
* Set objectives for the pension fund's overseas portfolio. What do you expect to achieve with your overseas portfolio? What is your performance benchmark? What is your risk benchmark?
* Articulate an international investment strategy. Go back to the first step in this process and enhance the pension fund's written investment policy with a statement of your international investment strategy and how you intend to carry out that strategy.
* Build allocation models. One of the most important determinants of the success of your international portfolio will be the allocation of the portfolio among countries, assets, sectors, and styles. The quantitative analysis which you did in the prior steps will allow you to make these allocation decisions. Do not rely on your overseas asset manager to make these decisions for you.
* Finally, select the best specialist international asset managers to manage your overseas portfolio. Manager selection belongs at the end of the process not at the beginning. Select managers who have a demonstrated ability to carry out the investment strategy which you have developed for the pension fund. If your strategy is to invest overseas in equities in developed countries, pick the best developed country equity managers. If your strategy in the United States is to do no more than match the performance of the S&P 500 Index, pick the best United States passive manager. You will not know which managers to choose until you know what your strategy and allocations are.