Overseas Risks

Terry Flanagan

CalPERS’ CIO highlights the risks of investing pension money in foreign markets.

As pension funds and other institutions seek to bolster their returns to meet impending financial obligations, they’re investing in fast-growing overseas markets while at the same time those markets pose some of the greatest risks.

“The big three risks that are weighing on the market can be labeled by geography: Europe, the Middle East and China,” said Joseph Dear, the chief investment officer of the California Public Employees Retirement System (CalPERS), one of the nation’s largest institutional investors with $260 billion under management.

Dear described those risks to the Calpers board Nov. 16, and the transcript of the meeting was released Nov. 22. On the European front, he said investors’ “drearily familiar” concern about the solvency of the European banking system would unlikely be resolved anytime soon. Distinguishing risk from uncertainty, he said that until the latter is lessened and there’s more assurance that enough liquidity and support will be available to prevent uncontrolled defaults and maintain banking solvency, markets will continue to gyrate.

“Uncertainty means you just don’t know, and you won’t,” he said, adding that until the necessary decisions are made to reduce that uncertainty, “investors will oscillate between optimism and pessimism and drive markets up and down accordingly.”

Dear described the Middle East as the dominant risk facing investors early this year, when the popular uprisings, starting in Tunisia and Egypt, threatened oil supplies and consequently the fragile world economy. He said that the ultimate impact of those uprising is unknown although “likely negative,” but what’s “driving the [Middle East] back to the forefront of the risk list is the recent report on the Iranian nuclear weapons development program and the rising risk of military intervention to disrupt it.”

Dear’s presentation to the Calpers board was before Egypt’s recent uprising seeking to shorten the country’s interim military rule, compounding the risk to oil supplies.

Dear pointed to the threat of a hard economic landing in China, after it powered its way through the global financial crisis with a massive stimulus program, as the third big risk. Nevertheless, he said, his reactions when recently visiting China after a three-year hiatus, were “first amazement and the second is terror.”

He was amazed at the country’s “phenomenal rate of growth and the determination of the Chinese to lift their nation out of poverty.” His terror stemmed from “the implications of China’s rise, and how dedicated, smart, determined the Chinese are.”

He added, however, that that the Chinese economy’s rapid growth is founded partly on less than dependable market practices and is bound to flounder, although whether next year or in 10 years is unknown.

Dear noted CalPERS significant exposure to Asia in general, including $1.3 billion in private equity, a like amount in public equity, and $500 million in real estate investments.

“The question is how to approach this, how to deal with the risk,” Dear said, adding, “Who we work with there, is more important in China and other emerging markets than anywhere else, and how we make those selections will ultimately determine the success of our investment.”

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