Multiemployer pension plans should consider changing their investment approach — including adding more alternative investments — in light of an aggregate funded status as low as 51%, according to a new report from Cambridge Associates.
Multiemployer plans' calculation of funded status reflects pension liabilities discounted at the plan's expected long-term investment assumption. Under this method, some 55% of multiemployer plans are at least 80% funded as of 2014, the most current data available.
“But, the reality is not quite so rosy,” the report states.
Cambridge estimates multiemployer plans have an aggregate funding gap of 51%, using return assumptions based on Aa corporate bond yields.
“Multiemployers plans have smaller allocations to alternatives” than other types of pension plans, Alex Pekker, senior investment director in Cambridge's San Francisco office and the report's author, said in an interview.
Multiemployer plans' approximate aggregate allocation was 50% equities, 22% fixed income (investment grade and high yield), 10% real estate and 18% other as of 2014, the most recent information available, according to a Society of Actuaries analysis of multiemployer plan data. By comparison, the top 200 U.S. defined benefit plans — corporate, public and union — had an average asset mix of 49.8% in equities, 25.1% fixed income, 7.2% real estate, 1.8% cash, private equity 8.7%, other alternatives 5.7% and other, 1.7% as of Sept. 30,2014, according to Pensions & Investments data. U.S. private colleges and universities' asset allocation was 34% equities, 8% fixed income, 54% alternatives and 4% cash, according to the 2014 NACUBO-Commonfund Study of Endowments.
These plans that cover union members face a number of challenges, Mr. Pekker noted. Among the biggest is their larger unfunded liabilities compared to other pension plans, and greater difficulty in bridging that gap because of their older populations, lower contributions and lower expected returns, he said.
To close the funding gap, multiemployer plans need to focus on alpha-generating investments, which include alternative investments. This is “especially important now when expectation for returns is low,” Mr. Pekker said.
“If there is no active management, plans will get market returns,” he said.
The 10-year prospective market return as of Dec. 31 for U.S. equities is 3%, emerging market equities is 10.1% and U.S. investment-grade bonds is 3.4% compared to 3.9% for hedge funds, 7% for private credit and 7% for private equity, the report indicates.
In selecting differentiated money managers focused on alpha generation, “it will be important to keep in mind that potential manager value-add varies greatly among asset classes, being highest in private equity and lowest in fixed income,” the report states. “And … managing risk with discipline and acuity is an important part of this equation.”
“Alternatives are not a panacea and are not suitable for every plan,” Mr. Pekkar noted. “There are many flavors of alternatives and some of them may be appropriate for these (multiemployer) plans.”
Some plans have shorter time horizons and would need more conservative asset allocations. Shorter time horizon plans include those that have smaller numbers of workers that still have union jobs, larger percentages of retired employees and/or include larger numbers of employees who are close to retirement age, he said.
The investment strategy for plans that have shorter time horizons would need to be more conservative, possibly including investments in direct lending, which have shorter lockups and are expected to provide cash flow, he said.
Multiemployer plans that have smaller percentages of workers with union jobs plans are typically more underfunded and have larger cash flow requirements than healthier plans that have a larger percentage of active union workers.