LGIM: US vs. Europe -- Who Wins With Equities?

(August 21, 2012) — The United States is outpacing Europe in terms of its financial strength, so deciding where to allocate to equities should be simple – shouldn’t it?

According to Lars Kreckel, Legal & General’s global equity strategist, the US economy is growing, while Europe is facing a seemingly endless recession. “The US has a proactive central bank willing to support growth, while Europe has a central bank focused on inflation rather than growth. The US has a political system capable of making decisions in a crisis, while Europe is governed by an unwieldy system requiring agreement of 17 heads of state from different political parties at different stages of election cycles,” Kreckel stated in a newly released paper.

However, while being overweight US equities may seem like a no-brainer, LGIM recommends being underweight the asset class in the US. “Before getting into the details of our argument we must mention an important caveat…Rather than focusing on absolute growth, we are more interested in comparing regions – assessing the prospects for US economic growth, equities and earnings, compared to the European equivalents.”

The paper continues: “European earnings forecasts have been under pressure for the past 18 months, but until recently US consensus forecasts had remained stable. With the Q2 reporting season this trend has changed. While European earnings are still under pressure, analysts have begun cutting some of their US estimates as well. The S&P 500 had its worst pre-announcement season of this cycle with over three times as many companies pre-announcing negatively than positively. In relative terms the earnings revision ratio now looks better (or less bad) in Europe than in the US for only the third time since 2009. Part of the pressure on US earnings comes from the stronger US dollar, which has appreciated 12% over the past year against a broad basket of currencies.”

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The most recent Merrill Lynch fund manager survey recorded that a net 13% of respondents were overweight US equities, roughly one standard deviation above the normal reading, Lars noted. Meanwhile, European equities recorded one of the highest consensus underweight positions in the past decade. “From a contrarian perspective this suggests the ‘buy US’ trade is overextended,” Kreckel concluded.

(August 21, 2012) — The Swedish pension system is set for an overhaul as a government-led report has recommended a series of measures to make it run more efficiently and maintain good investment returns.

Five of the six AP funds, which were created to act as a buffer that could cover Sweden’s pension payments should the government’s coffers fall short, were the subject of the report. In total, the five funds manage around €105 billion. AP7 was not examined.

The report recommended the number of funds to be cut from five to three and questioned the efficacy of AP6, a dedicated venture capitalist fund aimed at Swedish companies.

It recommended massive changes to the structure and management of assets.

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“The current assets of the Sixth AP-fund and the assets of the current First-Fourth AP-funds will together constitute the Pension Reserve Fund’s capital and be managed by the new agency, the Pension Reserve Board,” the report said. “The investment activities will be managed by three fund boards with identical mandates and the Sixth AP-fund’s assets will form part of one or more of these three funds.”

Instead of the current arrangement where each fund sets its own investment particular strategy, the report recommends a more uniform approach.

“Responsibility for the asset management of the pension reserve fund will lie with three independent and autonomous fund boards within the agency. The agency’s governing board will establish the investment objectives and mandates, which means that the funds will be managed and evaluated based on the same objectives and will be delegated identical investment mandates. Within the given mandates, it will be the fund boards’ responsibility to manage the funds prudently to achieve the highest possible returns. The fund boards may also instruct a securities intermediary or other capital manager to manage the fund’s assets.”

The funds are also set to change how their investments are made, the review stated.

“Current quantitative investment rules will be replaced with a prudent person principle, which means that it will be the fund boards’ task to, on the basis of risk limits and required rate of return, determine the assets and asset limits based on the chosen classification. The introduction of the prudent person principle presupposes the implementation of the inquiry’s other proposals concerning clear objectives and effective governance.”

The Swedish three-pillar pension system has been hugely influential and has been used as a template to countries starting up their own retirement structures.

The review was conducted by Swedish pension industry veteran Mats Langensjö and was called for last year by Peter Norman, the minister for financial markets, who had previously led AP7.

For the full report, click here.

LGIM: US vs. Europe — Who Wins With Equities?

Swedish Pensions Go Under the Knife