|
After making the same kinds of investment blunders as many individuals, corporate pension funds now are seeking the same remedies: fleeing stocks for the perceived safety of bonds. A growing number of pension managers are concluding their pursuit of maximum returns was a mistake, interviews with managers and consultants show. Instead, many funds are trying to achieve stable returns that more or less keep pace with the plan's obligations.
Corporate pension plans loaded up on stocks in the booming 1990s and had almost 70% of their money in them by the mid-2000s, a pattern similar to individuals'. By this July, pension plans as a group had cut their stock exposure to 45%, according to the Center for Retirement Research at Boston College. Many say the trend will continue.
Their caution damages a pillar of stock investing. With individuals also currently reducing their exposure to stocks, the market is left increasingly in the hands of investors such as hedge funds that often trade rapidly [[and faddishly: normxxx]], contributing to volatility. The pullback could be one reason the stock market has been choppy this year.
Some of the cutbacks at pension funds are the result of losses during the financial crisis. In a trend that began slowly in the 2000-2002 bear market and gained momentum when stocks took another dive in 2008, corporate pension managers have begun concluding that loading up on stocks in search of 'high returns' was a fool's errand. Corporate plans saw the value of the stocks they held at the market peak in October 2007 decline by about $1 trillion through early March 2009, according to the Center for Retirement Research.
On Finances
Video: Alphabet Soup
Video: Training Wall Street's Future Ranks
Video: Annuities, the Pros and Cons
Editors' Deep Dive: Institutional Investors Seek Stability
Dow Jones Capital Markets Report: Pensions Struggle With New Normal Yields
Investment News: Institutional Investors Look to Boost Returns
Private Equity Real Estate: Investors See Core Charm
"This was a slap in the face, definitely," for the pension world, says Ron Barin, chief investment officer for pension investments at Alcoa Inc. "Risk was never really a big part of the equation, and it really should have been". More recently, the May 6 "flash crash," when the Dow Jones Industrial Average fell 700 points in eight minutes before rebounding, further spooked some fund managers, sowing concerns about the role computers and high-frequency trading now play in the stock market.
The amounts at stake are large. Even though U.S. companies have long been reducing their use of pension plans, corporate pension funds still manage more than $2 trillion. A multiyear shift of nearly half of that sum to other kinds of investments is under way, according to McKinsey & Co. This would mean a movement of nearly $1 trillion to bonds and to alternatives such as hedge funds, private investment pools, annuities, derivatives and insurance plans.Not all would be removed from the stock market, but the overall effect is an extensive rebalancing away from stocks. "The reallocation is massive," said Onur Erzan, a McKinsey consultant. That conclusion is based on a 2007 study and on more-recent interviews with pension managers, asset managers, insurers, investment bankers and others who cater to the funds. Other evidence comes from a survey by benefits consultant Towers Watson of 100 large corporate pension plans in mid-2009. It found that, on average, they were planning this year to move 10% of their assets out of stocks and into bonds and alternative investments.
Click Here, or on the image, to see a larger, undistorted image."That is a sharp acceleration," said Carl Hess, the firm's global head of investment consulting. In the past, shifts had been more like 1% a year. Alcoa's U.S. pension fund had 57% of its assets in stocks in 2006. The stock market started sliding late in 2007, and by the end of 2008 the decline had pulled stocks down to just 33% of Alcoa's pension portfolio. The fund's value tumbled by more than $2 billion, to $6.5 billion.
Alcoa officials decided against restoring the stock exposure to its former level. With the blessing of the board, they looked for ways to insulate the fund from future damage. By early 2009, the board signed off on a plan to push stocks down to 30% of fund assets, selling shares and buying bonds. As the stock market surged back starting in early March that year, Alcoa continued to sell stocks to keep that weighting at 30%.
The change hasn't been painless. To bolster its pension assets, Alcoa in January contributed $600 million to the fund, in the form of Alcoa shares. Still, assets cover only 80% of pension obligations, and the company expects to make more contributions in the future, this time in cash.
Boeing Co. began de-emphasizing stocks in late 2006. Its pension plan had been hurt by the crushing 2000-2002 bear market. During the bull market that followed, Boeing decided it needed to make its holdings less volatile.
"In the past four or five years it dawned on us that it would be better to find a different way," said a Boeing spokesman, Todd Blecher. "We wanted to bring more stability to the assets". At the end of last year, Boeing cut the plan's stock holdings to 34% of assets, from 60% in 2004. Its goal is to move below 30%, shifting toward fixed income, real estate and hard assets such as commodities.
Boeing recognizes that the price of greater stability will necessarily be more contributions, because returns on assets in the fund are likely to be lower. Although the company contributed $1.6 billion in stock to the pension plan last year, it remains just 88% funded, leaving a gap of $6.4 billion. Both Boeing and Alcoa have moved to end pension coverage for some employees, shifting them to 401(k)-type retirement plans.
Among other big companies, International Business Machines Corp. and Pfizer Inc. reduced stock exposure in their funds in late 2007. PG&E Corp. and Time Warner Inc. announced shifts toward bonds in 2009. Exxon Mobil Corp. last year moved its U.S. pension plans down to 60% stocks from 75%, the first time it was that low in a decade. Although Exxon contributed $3.1 billion to the plans in 2009, they were still just 74% funded at year-end.
State and local-government pension funds, which oversee $2.8 trillion in assets, also have cut their stock exposure, but less deeply than corporate plans. The public funds' stock exposure exceeded 70% in 2007 and was about 65% last year. Governments don't have profits or stock they can contribute to pension plans, so they generally are keeping more risk, in hopes that the stocks they own will rise and reduce the need for contributions.
The reduction in stock exposure at corporate plans means many companies are likely to face the need to contribute more to their pension plans in future years. Pension-fund assets at the biggest corporate plans covered more than 100% of their liabilities in 2007, according to research from Goldman Sachs Group's Global Markets Institute. By this summer, partly because of stock declines after the 2007 peak, the assets covered only about 75% of the funds' obligations.Lockheed Martin Corp. was $10.7 billion under water at the end of last year, according to the Goldman data, while Ford Motor Co. was $6.2 billion behind. AT&T Inc. was $6.1 billion in the red and General Electric Co. $6 billion. The companies confirm those figures.
Companies with underfunded plans don't face an immediate need to bring them up to snuff. They have years to make contributions, so funding gaps aren't a threat to an otherwise-healthy company. Still, the deficits are a burden, and volatile pension-fund returns affect companies' earnings and balance sheets.
Congress recently authorized companies to delay some contributions even more. But only about 25% of companies may take advantage of this relief, a study by Towers Watson suggests, partly because of restrictions the law imposed. Either way, the study suggests, the minimum required contributions for all corporate plans, large and small, could rise as high as $160 billion as soon as 2012, compared with only $37 billion in 2008.
Over the long run, bonds have produced weaker returns than stocks [[but not since the turn of the millenium,: normxxx]]. So the corporate plans seem to be resigning themselves to more-limited returns at a time when they are underfunded, making it even harder to recover and spelling more pressure to cut future pension benefits. Some analysts worry that so much money has fled to bonds lately that they now could be overpriced and riding for a fall of their own. If so, the search for safety, by both pension funds and individuals, could backfire. [[But not really for full-term holders such as most of these plans. In the end, bonds pay off at par— only early sellers of premature bonds are subject to market instability.: normxxx]]
About two decades ago, in 1988, corporate pension funds had just 38% of their assets in stocks, according to the Center for Retirement Research. And 401(k)-type plans, in which individuals control investment decisions, also held less than 40% in stocks, according to the Center. During the stock boom of the 1990s, the percentage invested in stocks jumped for both groups, with individuals hitting 68% in stocks in 1999 and corporate pension plans hitting 67% in 2001.
Pensions remain an important part of retirement plans for many Americans, especially retirees. Among people still working, nearly a third of those with retirement plans in 2007 had some form of pension coverage, according to the Center for Retirement Research. That was down from 57% in 1993. Today's low interest rates are a disaster for pension plans, for two reasons. First, they squeeze returns in funds increasingly dependent on bonds. Second, for corporate plans, they boost pension liabilities. That happens because, mathematically, falling interest rates raise the present-day cost of future liabilities. Higher liabilities make the funding gaps bigger.
Interest rates for corporate bonds— the benchmark that corporate pension funds use to gauge future liabilities— have dropped close to multi-decade lows. The falling benchmark and resulting higher liability figures mean that corporate pension funds' gaps in funding have widened since the end of 2008 despite the stock-market gains since then. Funds' desire to reduce volatility also is fueled by a series of legal and accounting changes that have forced corporations to reflect pension-plan losses more directly on balance sheets and in earnings reports.
Many pension managers have begun thinking about their business in new ways. Instead of trying to boost returns as much as possible, many are trying to match their plan's expected income to the expected need to pay benefits, with the least risk possible. Pension consultants are pushing the strategy, called "liability-driven investing."
They offer to design mixes of bonds, annuities, derivatives and other investments with predictable maturities and yields that, if everything works correctly, will closely track payouts. Some companies are looking at insurance plans that cover future pension funding needs, in theory letting them terminate their pension exposure entirely. To do that, companies typically freeze their plans, offering no new pension benefits and shifting employees to 401(k)-type programs.
In eight major industries, new salaried employees were getting 19% lower retirement benefits as a percentage of pay in 2008 than in 1998, a Towers Watson study found. Many consultants expect a second wave of plan-freezing in coming years. "As the markets recover, we think that chief financial officers will move more aggressively now to close" pension plans, said a McKinsey consultant, David Hunt. Typically, a 'terminated' plan is one that has stopped offering new benefits and whose remaining liabilities are fully funded.
No comments:
Post a Comment