Two warning signals might be flashing in the statistics reported in this issue of Pensions & Investments: the high level of equity ownership by participants in corporate defined contribution plans, and the high level of sponsoring company stock owned by such participants.
P&I's survey of the 1,000 largest pension funds revealed that during the 12 months ended Sept. 30, 1996, corporate defined contribution plans' average equity commitment climbed to 62.6%, up 7.5 percentage points in just one year.
The figures are cause for both congratulations, and mild concern.
Congratulations are in order because employer efforts to educate employees about how to invest their defined contribution plan assets appear to be working. Participants have moved strongly out of low-yielding assets into stocks. The percentage of assets invested in stable value/GIC investments declined in the same period to 20.5% of assets from 28.6%.
Employees have received the message that common stocks offer higher long-term investment returns than bonds or stable value investments. No doubt, though, the bull market in stocks has encouraged participants to raise their equity commitments.
Mild concern is appropriate because the 62.6% equity commitment might reflect a growing belief on the part of many plan participants that the stock market is unlikely to suffer more than mild corrections in the future.
Most defined contribution plan participants have experienced at most one significant market correction - the 1987 crash - and from that they might have been convinced the market always bounces right back. The small corrections the market has experienced since then will only have served to reinforce that belief.
Plan participants might be in for much anguish if anything other than a short, sharp correction should occur in the future - a long, slow, apparently never-ending nosedive such as 1973-'74, for example.
The average allocation probably should not go much higher.
Perhaps the biggest cause for concern in the figures is that the average allocation to employer stock also climbed, and now accounts for almost one-third of all assets in corporate defined contribution plans.
This means participants are running very undiversified portfolios. Not only is their current income tied to the success or otherwise of their employers, but so, too, is one-third of their retirement nest egg.
Employees often have strong loyalty to the companies for which they work, even in these times of downsizing and mass layoffs, and this can color their analysis of the investment attractiveness of the stock of the employer.
In many cases employees did not choose to invest in their company's stock. More employers are making their matching contributions to 401(k) plans in company stock. And some restrict the freedom of the employees to then sell the stock and diversify. But even when the employees are free to sell, they are constrained by inertia or company loyalty.
There are remedies, however. One of them is not legislation.
One is for corporations to refrain from making company stock an option for employee contributions when the employers' matching contribution is made in company stock. Another is the abolition of any restrictions on the freedom of employees to sell company stock they receive as matching contributions, and additional education to make sure employees understand the risks of such high concentrations.
If employees knowingly and willingly decide to invest in their company's stock, Congress should not interfere.