Total assets held within the largest defined benefit funds across the globe grew at a faster rate in 2014 than 2013, according to the annual survey conducted by Pensions & Investments and Towers Watson & Co.
The reasons for that growth go beyond funds accumulating assets. Rather, the effects of quantitative easing and plan sponsors' eagerness to clear fund deficits by contributing cash have played a big part as well, industry experts said.
DB assets grew by 3.7% in 2014, compared with 2.6% in 2013, to total $9.79 trillion. Total assets of the 300 largest retirement plans in the world were $15.36 trillion, up 3.4% from 2013. Those 300 plans represented 42.6% of total global retirement assets, as measured by Towers Watson's Global Pensions Asset Study — a slight decrease compared with 2013, when the largest 300 retirement funds accounted for 43.7% of total global assets.
“One of the great problems facing DB plans is the low discount rate — that has pushed them into equities and risk assets in general,” said Gordon Clark, professor and director of the Smith School of Enterprise and the Environment at the University of Oxford, Oxford, England. “The compensation comes in the form of taking a lot more risk.”
He added that being in equity markets over the past few years has been “very rewarding, and I think that is what we see when we see growth in DB assets.”
With stubbornly low discount rates and interest rates, “private plan sponsors are trying to shore up the assets of the DB plan,” leading to some “having to dig into the coffers to make one-off, significant contributions to bring plans back into solvency,” Mr. Clark said.
But whatever the reason, it is still a positive sign.
“This is still accumulation, and the fact assets have doubled in the last 10 years says something about the health of the savings industry and savers,” said Chris Ford, Surrey, England-based global head of investment at Towers Watson. “Generally speaking, I would say it is a good thing. The challenge, however, is that the numbers are artificial, with policymakers still supporting the capital markets.”
Mr. Ford warned that things might look rosy, as assets are up, “but to a certain extent we have borrowed that money from our kids, because that is what quantitative easing does.”
Data for the P&I/Towers Watson World 300 are largely as of Dec. 31, and since then the U.K. and U.S. have pressed pause on financial loosening. “We are now starting to see that roll off slightly. The withdrawal of QE means that markets are beginning to function more normally, and so we have seen the return of volatility,” Mr. Ford said.
Last year saw a continuation of the positive effects of quantitative easing on risk assets, albeit to a lesser degree than in 2013. The Russell 3000 index returned 12.53% in 2014, vs. 33.5% in 2013; and the MSCI All-Country World index gained 4.76% in 2014 in U.S. dollar terms, vs. 23.5% in 2013.
Removing the U.S. from the equation results in a drastic change: the MSCI All-Country World index ex-U.S. was down 3.31% in 2014, vs. a 15.97% gain in 2013, in U.S. dollar terms.
Slowed growth overall
Despite the buoying effects of quantitative easing on risk assets, growth across the 300 largest retirement funds in the world slowed compared with recent years. Total assets were up 3.4%, compared with 6.2% growth in 2013 and 9.8% in 2012.
Outside of DB plans — which accounted for 66.8% of total assets, basically flat from 66.7% in 2013 — growth for other types of retirement funds decreased compared with 2013 rates. Defined contribution plans grew 4.7%, to account for 21.2% of total assets, about $3.1 trillion. That compared with 9.4% growth in 2013, but a 21% slice of total assets.
“The underlying growth relative to DB I don't think is slowing, but you are likely to have higher allocations to equities in DB vs. DC,” Mr. Ford said.
Mr. Clark acknowledged the slowed growth was “a little more of a puzzle,” but suggested that the propensity of target-date funds in DC plans could have had an effect.
“It is possible that for some of the bigger plans, where retirement looms, target-date funds may be contributing, automatically rebalancing away from growth and equities, to other types of assets like gilts and corporate bonds. Because target-date funds are now so significant in many larger plan sponsors, any maturing of the workforce will give an automatic rebalancing away from equities towards bonds. That could lower the rate of increase in DC assets,” Mr. Clark said.
The effects of currencies hit reserve funds and hybrid funds in particular. Reserve funds, which are set aside by national governments to guarantee retirement payments in the future, grew 1.4% vs. 15% in 2013, accounting for 11.3% of total assets, vs. 11.6% in 2013. Mr. Ford said the low growth was largely because of the fall in assets, in U.S. dollar terms, of the National Wealth Fund of Russia. The ruble depreciated 44% against the dollar in 2014.
Spain's Fondo de Reserva Seguridad decreased 32% in U.S. dollar terms, as the Spanish government used part of the reserve fund to pay retirement liabilities.
Hybrid retirement plans, which incorporate both DB and DC components, saw assets fall 2.5%, vs. 8.2% growth in 2013.
Mr. Ford said currency had again affected the rankings, with four out of the five funds seeing assets decrease in U.S. dollar terms — despite all five increasing assets in local currency. The only hybrid fund to show an increase in U.S. dollar terms was the Danish Sygeplejersker og Laegesekretaerer, which merged two of the funds it administers in 2014.
North America on top
North America remained the largest region in terms of assets, accounting for 43.2% of total worldwide assets, vs. 41.4% in 2013. Europe came in second, at 28.5% of the total, vs. 29.5% in 2013; and Asia-Pacific fell slightly to account for 24.1% of total assets, compared with 24.7% the year previous.
Among the top 20, U.S. retirement plans continued to increase their share, growing to 25.2% of the total $6.06 trillion of assets. Seven of the top 20 retirement plans were U.S. funds, the same seven as in 2013. However, that share remains lower than the pre-crisis level in 2007, when U.S. plans represented 36% of the top 20 assets.
“We saw good equity returns (in 2014,) and U.S. investors (tend to have) higher equity allocations. But when you have dollar appreciation, which we had, then dollar-denominated funds look like they have got bigger — but the liabilities have also gone up, so in a sense they haven't become fundamentally bigger,” Mr. Ford said.
All major currencies depreciated against the U.S. dollar in 2014, further buoying assets once converted into dollars for the purposes of Tower Watson's research. Japan's Government Pension Investment Fund, Tokyo, retained its top spot, with $1.14 trillion of assets. However, the yen depreciated 12.08% in 2014 compared with the dollar, skewing local currency asset growth of 8.6% to appear as a 6.4% decline in dollar terms.
The second-largest fund remained Norway's Government Pension Fund, Oslo, with $884 billion of assets, a 3% increase in dollar terms, but a 27.6% increase in local currency terms. The Norwegian kroner fell 18.53% vs. the dollar in 2014.
There was a change in third place. South Korea's National Pension Service, Seoul, gained 6% in dollar terms, to $429.8 billion of assets, supplanting Stichting Pensioenfonds ABP, Heerlen, Netherlands, whose assets grew 0.7% to $418.7 billion and slid to fifth place. In fourth was the Federal Retirement Thrift Savings Plan, Washington, which recorded a 12.6% increase in assets to $422.2 billion.
The other big change to the top 20 was new entrant ATP, Hilleroed, Denmark, whose assets grew 9.7% to $122 billion. It replaced Japan's Pension Fund Association, Tokyo, whose assets decreased 16.6% to $98.1 billion, and fell to 25th position.
The asset allocation for the top 20 retirement funds, on a weighted average basis, showed a preference for equities, alternatives and cash, at the expense of bonds, in 2014. The average allocation was 43.1% equities, 41.2% bonds, and 15.7% alternatives and cash. That compares with 41.2% equities, 44.9% bonds, and 13.9% alternative and cash in 2013.
Asset allocation is undergoing a rotation right now, Mr. Ford said. The Asia-Pacific region, which reduced its allocation to bonds to 56.3% in 2014, from more than 65% in 2013, is heavily skewed by Japanese pension funds.
“They are now being told to sell bonds and buy equities (and risk assets,)” Mr. Ford said. There is also a stronger focus on alternatives and cash across regions, he added, noting those classes made up 28.7% of assets in North America, 14% in Europe and “other” markets, and 6.8% in Asia-Pacific. Figures for 2013 were not available.
“We are seeing a rotation — we are in a world where people thought equities would go up forever, and that bonds were fine and would produce the returns they needed forever. That is changing, for different reasons, across the globe. Japan has been told to stimulate growth by investing elsewhere; Europe and the U.S. are looking at their large equity allocations (which are not producing the returns they want) and are moving,” Mr. Ford said.
Mr. Clark noted that: “Japan, through Abenomics, is trying to dig itself out of 20 years of stagnation, and one expression of that is liberalizing the GPIF, giving it more leverage, more scope if you like, in terms of asset allocation and international exposure. We will expect to see ... GPIF playing an increasing role in traded securities, but particularly offshore, not onshore. ”
Mr. Ford had a few words of warning, in particular for the DC world.
The money management industry on a global basis “has not really got its head around what being a fiduciary for millions and millions of individuals means, what propositions should look like, and how to manage risk,” he said.
But the business of money management is also facing change. “The largest funds are trying to invest in a much more diverse range of assets, while exercising greater control and reducing costs in their portfolios,” Mr. Ford said. “There are profound implications for the asset management industry there. If equities and bonds are not a great place to be, nobody wants managers in those spaces. In turn, alternatives managers are looking at the situation and rubbing their hands with glee — but the cost structure (for alternatives) is way out of proportion to the value proposition. Technology has moved on, where there are so many more alternatives, only these more sophisticated, very large plans can invest there.”
Direct investments in alternatives, as opposed to investing in funds, and control over portfolios will lead to substantial change in the way asset management looks, possibly in the next five, but certainly in the next 10 years, he said.
“A large plan with 5% to 10% in alternatives may be willing to invest in funds of funds. But for a plan with 20%, 30%, 40% in alternatives, there is no way you would stick it inside a black box with a funds-of-funds manager. The need to have control is great.”
For the remainder of this year, the debt overhang is Mr. Ford's central concern, since it will constrain growth longer term, and, in turn, constrain returns on assets. “As the economy delivers, rather than going to equity holders, it will be used to pay off the debt containing investment and growth. Beyond that, our view remains risk tilted to the downside — it is not that there is no upside, but it still feels to us that the downside outweighs the upside.”
For equities, a 5% to 6% return looks more likely in 2015 than 8%.
And Mr. Clark thinks turmoil in the markets — in particular China and emerging markets — will push investors toward safe-haven investment destinations. “(Those elements) are simply going to reinforce what's happening anyway, and that has been an increasing shift by non-U.S. funds towards the U.S. market.”
He said there are three reasons for this U.S. preference — the U.S. economy is doing better than most European economies; “it is perceived to be relatively safe in terms of protection of investments, but also safe in terms of lower bouts of volatility; but it is also perceived, because of the growth in population, to be a resurgent economy,” with long-term economic strength compared with other developed markets around the world.
Mr. Clark expects to see the U.S. not just as a favorable destination for non-U.S. retirement plans. He thinks market volatility might also encourage U.S.-based retirement plans “to stay at home a bit more than they have in the past” when it comes to investment. n
This article originally appeared in the September 7, 2015 print issue as, "Growth of top DB plans accelerates in 2014".