IMCO, USS and NBIM mull the risks of non-US dominant portfolios

The US has been an unparalleled driver of portfolio returns for decades, but investors are increasingly concerned that US-dominant portfolios are jeopardising precious diversification.

Like Canada’s C$86 billion ($61 billion) Investment Management Corporation of Ontario (IMCO), which recently reassessed how it will approach the US, placing a 50 per cent portfolio limit on the allocation for the first time even although US treasuries and dollar investments have been a great diversifier, and America’s public and private markets have produced stella returns.

IMCO’s new target is close to where the allocation currently sits, so the reduction will only be marginal, explains Rossitsa Stoyanova, chief investment officer of IMCO, speaking during a panel session at the Fiduciary Investors Symposium. The strategy, she adds, isn’t a consequence of IMCO believing the US is poised to underperform in the future but is driven by diversification.

“We think we’re too exposed to the US, and we think there’s a risk of the US dollar and US treasuries not being the source of diversification they used to be,” she told the symposium at Oxford University.

She said strategy at IMCO will focus on investing more in Canada, and in private markets IMCO is looking at opportunities in Europe and the UK where external managers are starting to bring more co-investment opportunities.

Fredrik Willumsen, global head of strategy research at Norges Bank Investment Management (NBIM) said the giant oil fund has an overweight to European equities compared to a market-cap-weighted equity benchmark in a strategy that has been in place for decades.

In recent years, this underweight to the US has contributed to “a very, very meaningful underperformance” to the market-cap-weighted alternative as returns and earnings growth for US companies have outstripped European companies.

In 2021, Norway appointed a Government Commission to look at how the next 20 years could be very different from the past 20 years when it comes to the fund’s returns, he explained. Now, a new expert group appointed by the Ministry of Finance is looking to see the extent to which geopolitics should have an impact on NBIM’s investment strategy, and will publish its first findings in January.

Willumsen said that the fund uses a large share of its active risk on real estate and renewable infrastructure, and hopes to reap benefits from that. Historically, external manager strategies in listed equities in emerging markets have also proved profitable investments for the fund.

“We have had a phenomenal performance from the managers that we have chosen in emerging markets,” he said.

Currency conundrum

At the UK’s £76.8 billion ($100 billion) Universities Superannuation Scheme (USS) strategy is focused on scenario analysis that highlights inflection points in energy, technology and geopolitics.

For example, USS explores how President Trump’s policies might impact capital flows and the global trade system, and how AI will reshape productivity growth and markets. Another analysis is exploring to what extent AI will lead to very concentrated gains where the key stakeholders are the primary winners, or if the technology creates winners across sectors.

Mirko Cardinale, head of investment strategy at USS said that scenario analysis is a powerful tool to try and navigate complexity and something the investor has used before when it worked with the University of Exeter to build narratives and a framework around the energy transition.

The current investment climate has led the investment team to think about its exposure to currencies and dollar assets. USS, like IMCO, has a large exposure to growth assets. The investor also manages liability risks through a hedging programme with a top-down currency programme.

“We think currencies should be looked at in the context of the overall portfolio,” said Cardinale, detailing a strategy that involves exploring the interaction between foreign currency exposures, equities and growth assets.

He explained that sterling tends to fall at times of market stress, which means foreign currency is a useful diversifier. The US dollar has been an important source of diversification and has historically behaved as a very safe currency. But now that could change.

“We are taking the view that the defensive property of the dollar will be slightly less than it used to be.”

USS has reduced its dollar exposure in favour of other currencies with defensive properties including the euro, the Swiss franc and the yen.

In another approach, the investor is also considering trimming some of its US duration exposure, and titling the allocation to the UK instead.

However, USS’s allocation to inflation via US TIPS  remains very attractive because of the impact of tariffs on inflation. Similarly, IMCO is also exploring the benefits of moving some of the allocation to US treasuries into allocations offering more diversification and inflation protection in assets like commodities or gold.

Investors reflected on the importance of diversification between fast-growing companies and companies with more stable cash flows. European stalwarts like Nestle and Diageo are not overvalued, and these types of companies also hold up reasonably well in volatile times.

But they questioned if a non-US dominant portfolio would be able to achieve the same resilience and innovation that investors have historically found in US markets. They said it is difficult to reallocate to innovative companies in China, and Europe needs to reform to become a more compelling destination for capital, including simplifying the listing rules.