Frontier Markets Pension Funds and Home Country Bias
Institutional investors are overwhelmingly concentrated in size and number within developed and emerging markets. This is both a driver and an outcome of highly-sophisticated economies that can produce and leverage wealth for continuous improvement. For this reason, the idea of ‘home country bias,’ really only applies to developed countries and has been most acute in places such as the United States, Japan, China, and Canada.
Frontier markets, on the other hand, are classified as ‘Frontier’ in large part due to inadequate or nonexistent financial systems that need to be fully developed in order to build up large asset pools from the creation and success of pension plans. Things are changing, but slowly.
In the recent Willis Towers Watson Pension Survey of the 300 largest pension plans, 9 were Frontier Market-domiciled.
There are others not included, but they are individually small in nature, other than the B and C funds within Chile. Even these that are listed have an AUM of over $300bn. What this means is that over the next few decades these funds will begin to assert themselves more and more.
From a Frontier Markets’ pension funds perspective, what is safe is not an easy question to answer. Liabilities are domestic in nature and track local inflation. Finding sufficient assets to hedge inflation domestically can be challenging in countries where there is no long duration bond market, and when there is, more often than not, is USD-denominated.
Investing in foreign assets within developed markets can sometimes be seen as the appropriate way to gain this safety by leaving currency unhedged. This approach typically relies on USD or EUR to appreciate sharply against a domestic currency in the event of inflationary pressures domestically. Wanting to leave foreign currency exposures unhedged is the opposite of US investors who tend to fare poorly when the USD is appreciating with a global portfolio.
One way to address a small domestic market as a pension fund is to invest in the closest large market, given the dependencies that are likely to exist. As an example, GIPF is based in Namibia, a country with only 2.6mm, so the fund invests its domestic mandate within South Africa. There is a small sleeve that is invested in Namibia, but it is not meaningful.[1]
BPOPF the pension fund for Botswana has an investment policy statement that mandates that at least 35% of the investment assets are kept within Botswana. This creates a material concentration issue for the fund as it is $7bn in size and the total market cap of the Botswana Stock Exchange is $4bn[2]. This is the type of issue that a pension fund in a Frontier Market often faces, maintaining domestic obligations versus fiduciary obligations that require diversification and risk mitigation.
Norway has the largest pension fund in the world and the second-largest sovereign wealth fund. The wealth generated by Norway is material and unparalleled in history. Norway is a small country, however, with only 5mm people and Norway made a decision to invest entirely externally with its government pension[3]. This diversification is a deliberate step, and certainly one that Frontier Markets could take.
However, Frontier Markets pension funds often feel the societal and governmental pressure to utilize what is often the largest pool of assets in the country towards development within the country itself. Pension Fund managers must tread carefully in their capacities as fiduciaries who must balance political objectives with investment return expectations. This was most recently experienced in Botswana with significant upheaval within the board and management of BPOPF[4]. Without the right governance structure in place, the decision often becomes home country bias vs. maximize returns and mitigate corruption. This paper does a great job of outlining this challenge.
We think this dilemma of managing home country bias while growing pension fund assets is a challenging one. From a purely objective perspective, a pension fund in a small country is likely better off investing in a global portfolio with limited investment within its home country. However, this is a risky proposition and does nothing to help the country itself with a large pool of assets. The optimal outcome would be a portion of the pension portfolio devoted to economic development activities within the country of domicile. This could include real estate development, corporate lending, incubators, and securitization. This is a role that Japanese funds have played the best and made a meaningful impact on the economic well-being of the country.
