Dark times have descended on the nation's pension funds.
Not only are pension executives dealing with negative third-quarter returns -- many in the double digits -- but they also may have to boost employer contributions or, for the first time in years, contribute again to the pension plan.
The negative returns are, of course, due to the global slide in securities markets. But that slide, coupled with a decline in interest rates -- including Oct. 15's Fed rate cut -- could mean fund liabilities will increase substantially.
Increased liabilities would decrease plan funding levels, resulting in "higher probabilities" of contributions to pension funds, said Steve Nesbitt, senior vice president and principal with the pension consulting firm Wilshire Associates, Santa Monica, Calif.
In the 1990s, most U.S. corporations -- and some state and local governments -- have had a holiday from making plan contributions.
Actuarial assumed rates of interest, the discount rate, for plans could fall to 5.5% or 6% from current levels of 7.25%, he said.
And as if that's not enough to pile on the pension executives' plates, they also might be forced to rethink their active/passive allocations, said Monica Butler, consultant at Frank Russell Co., Tacoma, Wash. Many active U.S. managers sold their strategies partly on the promise they'd perform well in a down market, yet their third-quarter numbers are expected to be significantly below their benchmarks.
Russell's performance statistics weren't available, but INDATA reports the median active U.S. equity manager reported a return of -13.2% for the quarter ended Sept. 30 -- 330 basis points lower than the Standard & Poor's 500 stock index.
The volatile third quarter has had other ramifications. A key factor in pension management, the validity of strategic asset allocation, is being tested.
"We have been in a really long bull market, and people have bought into the idea of strategic asset allocation, and we see many more funds today taking a really long-term strategic asset allocation and sticking with it, and rebalancing to it," said Ms. Butler.
"Now we are truly being tested. The key test today is whether or not people can stick with long-term asset allocation."
Some pension executives are questioning whether they should reduce their equity exposure and put more money in bonds, and whether they are as risk tolerant as they believed they were only one quarter ago, said Ms. Butler.
"Everything is being tested. I am not saying they are making changes, but they are questioning strategies."
She said Frank Russell consultants are advising clients to stick with long-term strategies.
One of the most disturbing aspects of the market drops is the "interdependence of the markets. Everything depends on something else. Nothing really stands alone," said Tom Herndon, executive director of the $76 billion Florida State Board of Administration, Tallahassee.
Equity markets fell in sync so fast, plans had to rebalance their portfolios repeatedly to keep asset allocation near policy target levels.
"I've rebalanced four times at least" since the beginning of the equity slide in July, said Mr. Herndon.
But Florida is sticking with its approximate 56% equity allocation.
For the third quarter, the Florida fund got a -7.4% return, according to a preliminary estimate, said Mr. Herndon. For the year-to-date, the plan has a positive 4.2% return.
From the U.S. equity market peak in July to its bottom in August, his plan lost 12.73% in value, but that loss was 22 basis points less than its customized benchmark, Mr. Herndon noted.
Pat Mitchell, chief investment officer for the $84 billion California State Teachers' Retirement System, Sacramento, said he also has rebalanced several times so his fund maintains its asset allocation.
CalSTRS' third-quarter return will likely be -10%, he said, well above that of most pension funds. But that performance partly stems from CalSTRS' higher than average bond allocation, he said.
The market slide hasn't put off the fund's plans to put $1 billion to $2 billion more in equity in the next few months.
The $133 billion California Public Employees' Retirement System, Sacramento, in effect, rebalanced through funding part of a new $3.8 billion domestic equity fund, said spokesman Brad Pacheco.
But at the end of September, based on CalPERS' preliminary estimates, the fund's allocation to domestic, international and private equity fell to 65.4% from 68.4% as of June 30. However, the system remains well within its targeted equity range of 60% to 70% of assets.
The biggest percentage equity change for CalPERS in the third quarter is in domestic equity. It fell to 44.6% of assets from 47.1%.
In absolute dollars during the quarter, CalPERS has $10.4 billion less in equity assets, but $1.8 billion more in domestic and international fixed income.
RISK QUESTIONED
Another worry is whether risk estimates for emerging market investments are right. The steep decline in emerging market stock values is, statistically speaking, beyond two standard deviations, said Wilshire's Mr. Nesbitt. In many cases, those estimates are based on a short history, 15 years at best, he said.
In a related concern, emerging markets moved downward in sync with developed markets for several days, similar to their movement during the Gulf War. Pension executives and consultants are reconsidering their assumptions about levels of correlations between emerging and developed markets, said Mr. Nesbitt.
Some plans probably are reconsidering any plans to put 5% to 10% of plan assets in emerging markets, he said.
Some pension officials are probably in shock, said Bob Helliesen, a consultant with the pension consulting firm Dorn, Helliesen & Cottle Inc., San Francisco.
The negative equity performance globally is "disappointing and a wakeup call" to pension funds used to getting fat equity returns, he said. Some funds will stay away from "tricky" new investments and those "not doing well."
The equity numbers made for depressing news at a September investment committee meeting of CalSTRS. Before consultant Allan Emkin started to review a pleasing second-quarter performance, he said, "I said it couldn't continue."
One CalSTRS U.S. small-cap manager, Denver Investment Advisors, lost 20% of the value of its portfolio in August. The $911 million it managed for CalPERS fell to $722 million by August. By the end of September, markets had improved somewhat. Mr. Mitchell estimates DIA finished the quarter with about a -17% return.
But a few investors consider the slide to have worked in their favor.
The $18 billion South Carolina Retirement System, for example, is preparing to put $7 billion in the U.S. equity market, a result of legislation that allows the fund to invest in equities. "This is what we were hoping" for -- markets to be cheap, said John Pownell, deputy state treasurer.
