Twenty years ago, Federal Reserve Chairman Paul Volcker was trying to starve inflation through high interest rates, the Three Mile Island nuclear plant narrowly averted a major disaster, and President Jimmy Carter warned the nation was afflicted by malaise.
Meanwhile, the DuPont pension fund was dabbling with financial futures, the General Telephone & Electronics pension fund had invested 4% of total assets overseas -- with an unheard-of target of 7% to 10% -- and the Southern Bell Telephone & Telegraph Co. fund had nearly one-quarter of pension assets indexed -- with Batterymarch Financial Management Inc., which later exited the passive business.
Overall, though, the biggest U.S. pension funds were invested almost entirely in domestic stocks, bonds and cash. Pension executives were just starting to tiptoe into esoteric areas such as international stocks and derivative instruments, and were edging into real estate in the belief that the asset class would provide a sound hedge against inflation.
A lot has changed during the past two decades. The top 100 pension funds had $270 billion in assets as of Sept. 30, 1979 -- a relative pittance compared to the $3.1 trillion the top 100 funds now hold.
But it's the evolving structure and sophistication of U.S. pension investment strategies that is even more striking.
"The one thing that I think that has really changed over the years has been the emphasis and understanding of diversification," said Rusty Olson, who has overseen Eastman Kodak Co.'s pension investments since 1972 and intends to retire in May.
As for many big funds, the biggest shifts for the American Airlines Inc. defined benefit fund has been to invest internationally and in private equities, said William F. Quinn, president of AMR Investment Services Inc., Fort Worth, Texas.
With one-quarter of AMR's pension fund assets now invested in overseas equities and another 6% in private equities, "about one-third of the assets have shifted," Mr. Quinn said, driven by desires to invest in a wider universe, improve performance and provide greater diversification.
Gun-shy toward stock
Acting in the shadow of the traumatic 1973-'74 bear market, pension executives still were gun-shy about taking on too much equity exposure. "There was a strong aversion to losing money given what had happened to the stock market in 1973-'74," said Jay Kloepper, director of capital market research for Callan Associates Inc., San Francisco.
Twenty years ago, the average equity exposure for the biggest corporate pension funds was 56% -- compared with 63.4% today. (The data from 1979 blend both defined benefit and defined contribution assets, although defined contribution plans were a far smaller proportion of the total than they are today.) When an average 4.3% allocation to private equities in 1999 is added in, the contrast is heightened.
Far more striking are the changed asset mixes for most U.S. public funds, as many restrictions on their ability to invest in equities, both domestically and abroad, have been lifted. Twenty years ago, the average allocation to equities among the public funds in the top 100 funds was 22%, compared with 61.1% today invested in public securities, and another 2.7% in private equity.
For example, in the fiscal year ended June 30, 1979, the then $6.5 billion California State Teachers' Retirement System doubled the size of its equity investments to 12.2% of total assets.
As of last Sept. 30, 67.9% of CalSTRS' $98.4 billion in assets were invested in publicly traded stocks. That's equal to $66.8 billion -- more then 10 times the size of CalSTRS' entire fund two decades ago.
Higher funding levels, of course, have made more aggressive equity allocations easier to live with, particularly for very well-funded pension plans. In 1980, 55% private pension plans were underfunded, compared with only 18% in 1998, according to Watson Wyatt Worldwide, Bethesda, Md.
Away from plain vanilla
Several factors encouraged the trend toward greater diversification.
The publication of data by Roger Ibbotson and Rex Sinquefield starting in 1976 provided justification for pension executives to take control of the asset mix. Ten years later, the publication of a paper by Gary Brinson, Gil Beebower and L. Randolph Hood saying that asset allocation accounted for 70% to 90% of returns dramatized that message.
"There was a move away from plain vanilla to more return-enhancing asset classes, and classes that offered more distinct correlations," said Jack Miller, vice president of business development for General Motors Investment Management Corp., New York.
Enactment of the Employee Retirement Income Security Act in 1974 was a critical factor in enabling pension executives to diversify their portfolios, said Eastman Kodak's Mr. Olson.
Unlike common trust law, which said that every investment in the portfolio had to be prudent, ERISA said investments should be looked at in the context of the entire portfolio, Mr. Olson said.
This enabled pension executives to take on more risk in specific investments.
The development of new tools also strengthened the hand of pension executives. The emergence in the early 1980s of optimizers -- enabling pension executive to pick the best asset mix at the lowest level of risk -- opened the way for more expansive asset allocations, Mr. Miller noted.
In 1980, Mr. Miller recalled, "the only place to get an asset allocation study was your consultant." The process was expensive and time-consuming. (However, it took until the 1990s for more sophisticated asset/liability modeling that related investments to pension liabilities to become popular.)
The development of computers made it far easier for pension executives to carry out their own studies. The efficient frontiers generated by these programs enabled pension executives to factor in the risk from investing in new asset classes, such as international equities.
Shift to specialists
This growing justification for seizing control of the asset mix engendered a shift to specialist managers.
By 1979, a move away from balanced management -- portfolios comprising domestic stocks, bonds and cash typically run by bank trust departments and insurance companies -- already was well under way among the biggest pension funds.
Pittsburgh-based Aluminum Co. of America, then with a princely $856 million in total pension assets, used 19 money managers, including boutiques as Brundage, Story & Rose; Fayez Sarofim & Co.; Fischer, Francis, Trees & Watts; and Pioneering Management Corp.
What's more, index funds, now a mainstay of institutional investment, were only a few years old, and viewed as "unpatriotic" by some. But Burton Malkiel's 1973 landmark book,"A Random Walk Down Wall Street,"encouraged the trend.
Now, indexed equity accounts for 23.7% of top 100 assets, while total indexed assets comprise 27.5% of total top 100 assets.
The high interest rates of the late 1970s and early 1980s also encouraged a shift into bonds, as many large pension funds sought to match their liabilities with dedicated or immunized bond portfolios. American Airlines locked in a 16.3% portfolio in 1980, and another yielding 15.25% a year later, Mr. Quinn related.
A shift to specialist portfolios also presaged new ways to evaluate investment performance. "Twenty years ago, and even 10 years ago, managers were obsessed with absolute return," said Gregory C. Allen, executive vice president at Callan. "Managers came out to the board and said, `I did 20% last year,' and people said, `Great job.' "
Today, numerous asset classes and subcategories have emerged. They are organized by market capitalization, style bias, developed and emerging markets, to a host of fixed-income styles and instruments. And customized benchmarks have been created to track those different styles.
Meanwhile, illiquid assets, such as venture capital and buyout funds, weren't even on the scene 20 years ago.
The question is, however, with a multitude of asset classes to choose from, are pension executives better off?
"No, I don't think so," said Michael R. Beasley, managing director at Strategic Investment Solutions Inc., San Francisco. The huge variety of choices creates confusion for plan sponsors, who are pressured to hire managers for every variety of assignment, but each manager must handle a meaningful stake to make a difference in the total fund's return, he said.
"I think it's tough for sponsors because they have to figure out what is truth," Mr. Beasley said.