Pension Funds Flee Stocks in Search of Less-Risky Bets

Don’t think pension fund managers are any smarter than the average investor. Moreover, they are generally advised by consultants and actuaries whose principal activity is rear-view mirror gazing.

[DESTOCK-p1]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.

Risk management is the everyday job for managers and consultants. Yet

"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."

Big $ are moving, obviously a headwind for equities while it lasts.

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.(…)

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.

"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.

Earnings impact that analysts generally do not factor in their estimates:

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. (…)

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.(…)

Over the long run, bonds have produced weaker returns than stocks. 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.

Back to the future:

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.

That is exactly what they used to do (and should be doing), way back when, before CFO’s discovered they could reduce pension contributions and increase profits by maximizing returns…

Full WSJ article


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