SAN FRANCISCO - Callan Associates Inc., predicting turbulence in the domestic stock market, is recommending pension executives trim their U.S. equities exposure in favor of domestic bonds and international stocks.
In its latest five-year capital markets forecast, the San Francisco-based investment consulting firm also recommends employers boost their exposure to real estate, which provides a steady flow of income, rather than capital appreciation.
Callan doesn't anticipate bonds will outperform stocks over the long run. Rather, Callan predicts that when the stock market makes its much-anticipated nosedive, the spread between U.S. stocks and bonds will narrow to about two percentage points, well below the historical norm of three to five percentage points.
Callan predicts the Standard & Poor's 500 index will earn 9.3% annually over the next five years, while domestic bonds will earn 7.2%, said Michael O'Leary, executive vice president in Callan's Denver office. The firm also expects international stocks to earn 9.9%; foreign bonds, 7.1%; and real estate, 8.5%.
Consequently, Callan suggests pension funds can achieve target returns of up to 8.75% with lower risk by paring back their large-capitalization domestic equity exposures three to four percentage points and increasing exposure to bonds, international stocks and real estate.
While it might be difficult for pension executives to make such changes, especially with the stock market at lofty levels, at least one has done so already, Mr. O'Leary said. He wouldn't identify the client.
But Callan's competitors and some other clients disagree strongly.
Steve Nesbitt, senior vice president, Wilshire Associates, Santa Monica, Calif., said Wilshire doesn't see any major asset allocation shifts this year, and doesn't expect increased volatility in the U.S. stock market.
Wilshire sees U.S. and international stocks earning 9.5% annually over the next 10 years, and emerging market stocks producing 11.5% returns.
Segal Advisors Inc., New York, doesn't recommend clients change their asset allocations in tandem with capital market forecasts, but rather consider their need for cash to pay retirement benefits, said Alexander Sussman, senior vice president. "We don't make that call," Mr. Sussman said.
The Consolidated Rail Corp. pension fund, Philadelphia, a Callan client, uses target returns as its starting point for an asset allocation mix, rather than attempting to maintain a pre-determined risk level, said Thomas J. Conroy, assistant treasurer. The $1.2 billion plan, which is in the midst of an asset allocation study, has no plans for cutting back on domestic stocks and increasing its domestic bond allocation because it already has a conservative exposure to equities, he said.
The fund has a 43% target for domestic equities, 15% for international stocks, 26% for domestic bonds, 5% for global bonds, 3% private equity and 3% managed futures. The fund also has a 5% target allocation to real estate, but contrary to Callan's advice, is considering eliminating that asset class and getting the exposure through its domestic equity allocation, Mr. Conroy said.
The fund only has about 3% in real estate now.
Edward Overton, retirement adSee Callan on page 46Continued from page 6
ministrator at the $2 billion San Jose (Calif.) Retirement Systems, says Callan's latest forecast is nothing new.
"They have been predicting that for a couple of years."
The fund, which uses Callan as a consultant, wanted to increase its equity exposure some time ago, but Callan recommended against doing that. The fund has kept a 36% target for domestic equities since its fall 1995 asset allocation study, "and we feel like we have given away returns," Mr. Overton said.
The fund, Mr. Overton said, "would have been much better off to have had a much higher exposure to equities."
With its already low exposure to equities, and high exposure (45%) to domestic bonds, the pension fund is unwilling to accept any advice suggesting a further cutback.
"I don't see the environment, even with more risk (in equities) where bond returns will be good enough to supplant equities in the portfolio," Mr. Overton said.
