Pension systems in the U.S. face a host of issues when investing their billions of dollars in overseas real estate, and one key is understanding the difference between “emerging” and “frontier” markets. One leading investment advisor, the Pension Consulting Alliance (PCA), defines an emerging market as having at least one of the four following characteristics:

  • The market is located in a low or middle-income economy as measured by The World Bank's gross national income per capita.

  • The market does not exhibit financial depth; the ratio of the country's investable market capitalization to its gross domestic product is low.

  • There are broad-based discriminatory controls for foreign investors. Stock markets that maintain or introduce investment restrictions, such as foreign investment limits, capital controls, extensive government involvement with listed companies, and other legislated restraints on market activity — particularly those pertaining to foreign investors — are generally considered emerging markets.

  • The market lacks transparency, depth, market regulation, and operational efficiency. Emerging markets generally lack rigorous market supervision and enforcement, corporate governance practices, minority shareholder rights, transparency and disclosure, and a high level of accounting standards.

Christy Fields, a managing director with the PCA, notes that emerging markets are distinct from frontier markets, which are smaller and more illiquid. Specific examples of frontier countries on Fields' list include Bulgaria, Croatia, and Romania in Europe; Botswana, Cote d'Ivoire, Kenya and Lebanon in the Middle East and Africa; Ecuador and Jamaica in Latin America and the Caribbean; and Bangladesh and Vietnam in Asia.

As pension funds drift farther into international investment waters, a raft of new issues also arise concerning corporate and social responsibility. Public pension systems, such as CalPERS and CalSTRS, have been urging companies in which they invest to do more to help local communities and be more responsible corporate citizens at home and abroad.

This same stance is likely to apply to countries in which they invest. As evidence, recently the U.K.'s International Corporate Governance Council appointed Christopher Ailman, chief investment officer at CalSTRS, to its board of directors. The council is a network of global investors and money managers that works on international accounting standards, shareholders' rights and securities regulation.

Meeting corporate and social responsibility mandates is not without pitfalls, particularly at public pension funds. “Typically the pension system staff is fairly thin because you're on a state budget, and lots of staff time is eaten up by trying to work out procedures and policies that comply with all these corporate and social responsibility mandates,” says Lennine Occhino, a partner in the Chicago-based law firm Mayer Brown.

“You sometimes lose some of the best staff because they are investment professionals and they get frustrated if they feel they are not able to perform well because of state constraints,” she says.

“Nowadays, I think global investing is so essential,” says Occhino. “It's pretty apparent you can't limit your portfolio to the U.S. markets. You have to invest globally, and these social restrictions have a very big impact.”