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Los Angeles Fire and Police Pension Department Eliminates Dedicated Emerging Markets Account
By: Brian Churchill, Los Angeles Fire and Police Pensions
For the last 45 years, the Los Angeles Fire and Police Pension Department has targeted investments in emerging markets. After a calculated shift of investment strategy, that is no longer the case. In July 2024, the Board of Los Angeles Fire and Police Pensions Commissioners decided to completely eliminate its dedicated Emerging Markets (EM) account, due to major concerns over increasing geopolitical risks coupled with the account's low long-term performance. The decision marked a major departure from the $33 bn fund's previous 5% allocation to emerging markets and came after extensive study and debate regarding the future of EM investments in the portfolio.
A few years ago, emerging economies were well worth a look. Investing in such markets could translate to rapid growth and greater return, with BRIC nations (Brazil, Russia, India, China) showing explosive growth in the last two decades. But increasingly, emerging markets meant factoring in more risk—supply chain disruptions, tensions in the region—and as of late, that risk overshadowed the reward.
The decision to remove the EM allocation followed a series of reviews and presentations, beginning in 2022. LAFPP staff emphasized that the emerging markets allocation had significantly underperformed compared to developed markets. Over a 15-year period, the annualized net return for emerging markets was -0.18%, compared to 1.94% for developed markets. Ten-year figures told a similar story: emerging markets yielded 1.93%, developed markets' far higher at 5.26%.
High fee structures also played a factor in eliminating the allocation. We found that our actively managed EM portfolios carried an average fee of 43 basis points (bps), compared to 31 bps for developed market portfolios. The discrepancy could largely be attributed to the higher costs associated with managing EM investments, where data is harder to obtain, and there are more countries to monitor.
LAFPP then looked past the numbers. Through a big picture lens, it was clear that geopolitical risks were growing rapidly and that volatility made emerging market equities not just financially less appealing but ethically questionable.
Zeroing in on China, which made up 60% of LAFPP investments in the EM account, China's role in global conflicts, particularly as a vital partner for Russia in their war of aggression against Ukraine, couldn't be overlooked.
While the Chinese government has denied supplying weapons, experts agree that they're building up Russia's war machine with critical components. More specifically, 70% of the machine tools and 90% of the microelectronics Russia imports come from China and trade between the two countries increased 64% between 2021 and 2023.
These actions spotlight a question that LAFPP had been asking for years: should we restrict the fund's exposure to China or should these decisions be purely by the numbers? As the largest economy within the EM category, China had been a focal point of discussion among institutional investors. But despite impressive economic growth, China's government interventions in capital markets, ongoing geopolitical tensions with Taiwan, its treatment of Uighur Muslims in the Xinjiang region, suppression of democratic freedoms in Hong Kong, and most critically, a relationship with Russia that appears to be growing stronger, there were serious concerns raised about the stability of investments there.
LAFPP investments could have indirectly funded Chinese companies involved in the development of military technologies and strategic infrastructure, now directly aiding Russia in their war of aggression.
These Chinese companies, while not always directly listed as defense contractors, often have dual-use capabilities, serving both civilian markets and military applications. According to an analysis of Chinese customs data by the Carnegie Endowment, Beijing exports more than $300 million worth of dual-use items to Russia every month. These numbers raised both ethical and security risks for LAFPP, whose beneficiaries could have serious reservations regarding their pension funds supporting adversarial foreign powers.
Beyond the ethical questions, a real risk was felt that U.S. regulatory bodies could impose restrictions on such investments, potentially leading to financial losses.
As Commissioners, we recognized that these risks could undermine our ability to secure stable, long-term returns for pension beneficiaries. By eliminating dedicated allocations to Chinese markets, LAFPP further aligned its portfolio with ethical investment standards.
Following a detailed review, LAFPP's energy pivoted to reallocation.
The reallocation strategy involved increasing developed markets equity by 2% and raising allocations to private equity, private credit, and commodities by 1% each. This new allocation seeks to maintain similar benefits as found in EM markets, such as diversification and lower valuations relative to U.S. markets, while minimizing the risks.
Eliminating EM markets and focusing on reallocation has important budgetary implications. Per LAFPP estimates, removing the EM allocation will save approximately $4.9 million per year in management fees. (This figure is based on a savings of 40 basis points on the $1.22 billion market value of emerging markets allocation as of December 31, 2022.) The reduction in fees is a direct benefit of shifting assets to less costly developed market investments.
While the board has eliminated its dedicated allocation to emerging markets, LAFPP has not entirely excluded these regions from its portfolio. International Markets managers with expertise in emerging markets will still have the discretion to source opportunities in these regions and present them to the board for approval.
LAFPP's reallocation away from emerging markets marks a major strategic shift in the management of the fund's international equity portfolio. The decision reflects a broader trend among institutional investors to prioritize stability and long-term security over the potential for high-risk, high-reward opportunities in volatile regions. By reallocating assets to developed markets, private equity, and commodities, LAFPP aims to strike the right balance between diversification and risk management, while also reducing fees and maintaining a focus on strong, consistent returns. LAFPP's move to shift away from emerging markets may serve as a model for other public pension funds facing similar challenges.
Disclaimer: The views and opinions expressed in this article are solely those of the author and do not necessarily reflect the official policies or positions of the Board of Commissioners or the Los Angeles Fire and Police Pensions (LAFPP).
About the author: Brian Churchill is an elected Commissioner for the Los Angeles Fire and Police Pensions. He is also a Lieutenant with the Los Angeles Police Department, currently working in the Internal Affairs Division. He concurrently serves as a Lieutenant Commander in the Coast Guard Reserve, in the Port Security field. From 2018-19 he was a White House Fellow, working as the Senior Advisor for the Indo-Pacific at the Overseas Private Investment Corporation. Brian earned a master's degree from the University of London, and a bachelor's from Boston University.
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