Assets of the 1,000 largest U.S. employee benefit funds topped the $3 trillion mark for the first time ever, thanks to dazzling returns in the domestic equity and fixed-income markets.
Total assets of the top 1,000 funds grew 15% to $3.128 trillion in the year ended Sept. 30.
The growth stands in stark contrast to the modest growth in the prior year. During the year ended Sept. 30, 1994, assets of the top 1,000 funds grew only 2.2%, in a year of relatively flat and negative returns in domestic financial markets.
Defined benefit assets among the top 1,000 largest plans grew 14% to $2.351 trillion as of Sept. 30, according to the 18th annual Pensions & Investments survey of the 1,000 largest employee benefit plans. Defined contribution assets increased 13% to $739.6 billion.
Despite the healthy increases on an absolute basis, the funds actually suffered negative growth on a market-adjusted basis. Assets of the top 1,000 employee benefit funds were 3.6% less than they should have been had their investment returns matched the indexes in proportion to each asset class in which they invest. One partial explanation: Benefit payments continue to outstrip contributions.
On a market-adjusted basis, defined benefit assets of the top 1,000 plans should have grown 4.9% more than they did; defined contribution assets should have grown 4.2% more.
The 200 largest funds - profiled in this issue - grew 18% on an absolute basis, to $2.441 billion. On a market-adjusted basis, the top 200 assets dropped 1.9%.
Defined benefit plans in the top 200 increased 18% to $1.9 billion in the year ended Sept. 30; on a market-adjusted basis, they should have grown an additional 2.3%. The defined contribution plans among the top 200 were up 18% on an absolute basis, but essentially flat on a market-adjusted basis.
The nation's pension funds had some big benchmark returns to contend with during the year - the Standard & Poor's 500 Stock Index was up an impressive 29.74% for the 12 months ended Sept. 30, while the Salomon Broad Bond Index was up 14.06%.
Other significant findings in the 1995 P&I survey include:
Contributions to defined benefit plans were up 31% among the top 200 plans, while benefit payments were up 16%.
Benefit payments still exceed contributions, however. Benefit payments totaled $75.93 billion for the top 200 defined benefit plans, compared with $53.12 billion in contributions.
The allocation to company stock in the top 200 defined contribution plans dropped noticeably to 18.2% in the year ended Sept. 30 from more than 25% a year earlier. At the same time, the allocation to non-company stock increased to 32% from 23.6% a year ago.
The top 200 defined contribution plans reduced their allocations to guaranteed investment contracts and stable value funds to 14.7% as of Sept. 30 from 21% the previous year. Defined contribution plans in the top 1,000 reduced those allocations to 16.6% in 1995 from 24.8% a year ago.
The commitment to non-investment-grade bonds by the top 200 pension plans nearly doubled, to $4.87 billion from a year ago.
J.P. Morgan Investment Management Inc., New York, held on to its top spot as the money manager most often mentioned in the rosters of defined benefit plans among the top 200. Morgan was followed by Capital Guardian Trust Co., Los Angeles, and Brinson Partners Inc., Chicago. TCW Group, Los Angeles, which was second in last year's survey, dropped to seventh place in 1995.
Thomas Larkin Jr., president of TCW, said he couldn't explain the firm's drop in the rankings. "All the clients we had in 1994 among the largest 200 plans are still clients today," he added.
Industry sources point to the multiple product offerings of the most frequently mentioned money managers as the reason for their success. The loss of several senior executives in the TCW high-yield and distressed securities division in March also might have temporarily damaged the perception of TCW, they claim. Senior portfolio manager Howard Marks and several TCW executives left in March 1995 to form Oak Tree Capital Management.
"They had been perceived as a strong organization and losing these staff members was a big blow," said one consultant who wished to remain anonymous. "It hurt the perception of the firm and may have caused a loss of focus but it is a big strong multiproduct firm and they should recover nicely this year," he said.
The growth in plan sponsor contributions could be due to the Retirement Protection Act of 1994. The RPA accelerated the funding schedule of plans that were less than 90% funded and required severely underfunded plans to have enough cash and marketable securities to make current benefit payments. In addition, the RPA increased Pension Benefit Guaranty Corp. premiums for some underfunded plans.
"The (legislation) tightened the formula for minimum funding and contributions; it was a real surprise for some plans who had no idea it was going to increase their contributions. This legislation was probably a big part of the reason for the increase in contributions," said Tom Pipich, principal and investment consultant with Buck Consultants, Pittsburgh.
And the jump in contributions is probably bigger than the P&I figures show. Not all sponsors report their contributions or payouts, and this year that list includes General Motors Co., which in March contributed $10 billion in stock and cash to its funds.
Downsizings affected payments
Lackluster market returns in 1994 also caused a strain on some defined benefit plans, resulting in the need for increased funding, Mr. Pipich said.
Early retirement programs taken by employees in the wave of corporate downsizings and restructurings probably were responsible for the jump in benefit payments, said Mr. Pipich.
"The large number of downsizings may have pushed many into a (pension) pay status earlier than anticipated; downsizings could push benefit payments up," he said.
The growth in equity allocations among the top 200 pension funds is primarily due to the healthy gains in the securities markets during the year and represents an acceleration of a trend toward the use of equities.
The most dramatic and, apparently, deliberate shift in equity allocation is in defined contribution plans where the decline in the use of the sponsor's stock as an option corresponds with an increase in the allocation to other stocks.
"What has been happening is that both participants and corporate management are more sensitive to specific risk in any securities, even their own. Even in boardrooms, there is the growing recognition that having a lot of company stock increases risk," said Mr. Pipich. "By moving to other equity options, it looks like plans are moving from specific stock risks to a broader market exposure."
Ron Peyton, president of Callan Associates Inc., San Francisco, said strong education and investment training efforts by plan sponsors and mutual fund companies may have stimulated the shift away from company stock toward a more diversified equity approach.
"Education programs by plan sponsors and mutual fund complexes have very much heightened the need for diversification. That and a robust equity market have stimulated that movement, and it makes good sense," said Mr. Peyton. "If you understand anything about diversification you would start putting money into a diversified mutual fund rather than an individual stock. Corporations have lessened the emphasis on company stock because of legitimate concerns about volatility and would rather see more diversification and are now offering better alternatives."
GIC allocation drops
Another pronounced change in defined contribution asset allocations involves the drop in the traditionally popular stable value or guaranteed investment funds.
While GIC funds remain among the most heavily used defined contribution plan options, the P&I survey indicates education programs have convinced many participants to take a longer-term view of their investment plan. Many are looking more closely at the equity options, said Mr. Pipich.
"We are seeing participants finally getting the idea that any type of stable value investment is not really ideal for the long run, even though GICs did outperform almost everything in 1994," said Mr. Pipich. "But GICs are not an asset with a long-term characteristic to it."
Participant education and training programs designed to help employees structure defined contribution plan investments for retirement needs have emphasized the long-term benefits of investing in equities, said Mr. Pipich. "People are now starting to invest their retirement funds with a longer-term perspective than what their next quarterly statement shows in earnings; there is almost a drumbeat of stories and information, even at the local level, pointing out the disadvantages of short-term investments and GICs and emphasizing the long-term value of equities," he said. "People are starting to be sensitized to this."
Among the top 200 defined benefit plans, the aggregate commitment to non-investment-grade bonds nearly doubled to $4.8 billion, which, according to consultants, may signal a renewed interest in the junk bond market not present since the days of Drexel Burnham Lambert in the 1980s. Others, however, believe economic factors could again dampen interest in the high-yield market.
Mr. Peyton of Callan said the higher allocation to high-yield bonds could be due to above-average returns for the sector in 1995. The Salomon Brothers High Yield Bond Index returned 15.8% for the 12 months ended Sept. 30, which was higher than the Salomon Broad Bond return and lower than S&P 500 returns.
"Plans are recognizing that this has been a tremendous year in the financial markets and are looking for ways to earn higher incremental returns by looking at other asset classes," said Mr. Peyton. "They are looking at emerging market debt and private equity, and it makes sense they would look at higher yielding fixed income instruments as well."
Junk bond warning
However, he warned, the same factors that caused the junk bond to collapse in the 1980s could affect the market again if interest rates turn around.
"Anytime you have more money chasing an asset class it could set up the circumstances for another decline. Everything is fine as long as these companies can make their interest payments, but any change in the economy could change all that," he said.
The P&I survey also found:
The allocation to equities among the defined benefit funds in the top 200 increased to 56.2% from 53.7%. Among the top 1,000 plans the defined benefit equity allocation increased to 56.3% from 53.9%.
Bond allocations among the top 1,000 plans remained relatively static at 33.9% in 1995 vs. 33.6% the prior year. Among the top 200 defined benefit plans, the bond allocation declined to 34.1% from 35.3% in 1994.
For defined contribution plans among the top 1,000 largest plans, fixed-income allocations declined to 16% of total assets from 14.5% in 1994. Among the top 200 defined contribution plans, fixed-income allocations held steady at 17.4% in 1995 compared with 17.2% in 1994.
Defined contribution plans in the top 200 had $5.33 billion invested in lifecycle funds. This was the first year P&I included a question on such funds.
Internally managed domestic equities, for the first time, surpassed internally managed domestic fixed income. Top 200 defined benefit funds reported internally managing $285.2 billion in domestic equities vs. $263.7 billion in domestic fixed income (see story on page 18).
Total indexed assets under management among the top 200 defined benefit funds rose 15.5% to $377.5 billion as of Sept. 30; indexed equity assets (domestic and foreign) rose 28% to $319.5 billion, while fixed-income indexed assets dropped 24.5%, to $58 billion from $76.8 billion (see story on page 72).