More pension funds are conducting asset allocation studies because of the ongoing market downturn and poor prospects for future returns, pension fund consultants say.
"We have lived through seven straight quarters of down markets, and at the same time interest rates have fallen, leading to increasing liabilities for pension funds. Many (funds) are struggling to determine whether they can meet their assumptions, and if they will need to raise their contributions," said Rodger Smith, partner at consultant Greenwich Associates, Greenwich, Conn. These difficulties are spurring an increased number of funds to do full-blown asset allocation studies or more moderate reviews of their asset mix, Mr. Smith and other industry consultants observed.
Ronald Peyton, president of Callan Associates, a San Francisco consulting firm, noted the quantitative unit at Callan that conducts these studies is busier than he has ever seen it. "There is four times the level of normal activity," Mr. Peyton said. "This prolonged market decline has raised the need for renewed contributions from both corporate boards and government organizations. That's the impetus for the studies ... the need to reassess strategy and to validate it as a defendable course of action. Many pension funds have been on a contribution holiday. They haven't had to make any contributions for the last 10 to 15 years. But most government bodies and corporations are going to have to do that now, and it will be hard for pension fund trustees to reintroduce that concept."
While pension funds do asset allocation studies every five years on average, the number started to creep up in the last 18 months as the stock market failed to rally.
Some pension funds want to fine-tune certain changes they already have made, Mr. Peyton added. "They've been looking at alternatives, particularly private equity and real estate. Some with programs in place are expanding them. They're also looking more closely at the structure of their domestic equity managers, to incorporate segments such as small-cap and midcap that they might not have had before."
Pension funds act
Among pension funds that have been undertaking these studies:
* The $6.6 billion pension fund of International Paper Co., Stamford, Conn., which is in the middle of an asset allocation study. Said Chief Investment Officer Robert Hunkeler: "We were due for one anyway, but between the declining interest rates and declining asset returns, we have gone from being extremely well funded to just well funded. It's been like falling off a cliff, especially after Sept. 11. And that's what triggered a study. After it's concluded, we expect it will lead to some changes in strategy and the possible addition of an asset class, but we won't know the results until the end of the second quarter."
* The $10.6 billion San Francisco City & County Employees' Retirement System, which is completing a liability analysis that will be followed by a review of the asset allocation policy, to be concluded by the end of the summer. Said Executive Director Claire Murphy: "Normally the system does one every three to five years, but in the past year or so there have been several increases to benefits for all employees who retired since 1976, which has raised liabilities significantly. At the same time assets have fallen, so it seemed important to do one now. We haven't had to make contributions for years because we were overfunded at a rate of 130.5% as of June 30, but that's down from 138% the year before."
* The $3.1 billion pension fund of ITT Industries Inc., White Plains, N.Y., which plans to do an asset allocation study in the next quarter or two. "We should do one every five years, and the last full one we did was in 1997-'98, so it's overdue," said Clayton Young, assistant treasurer. "We need to revisit all of our assumptions. We want to see what our objectives should be and find the strategy to get us there," he noted, adding a study probably will lead to changes. While Buck Consultants Inc., New York, is the plan's actuary, ITT may use someone else for the asset allocation study, Mr. Young said.
* The $96 million pension fund of Madison Gas & Electric Co., Madison, Wis., which has been studying its asset allocation in relation to its peers to see if changes should be made, said Amy Sonnenburg, employee benefits manager. "The last time we did a study was in 1996, and we hadn't really revisited it until the third quarter of 2001. After Sept. 11, we rebalanced our fund after losing ground in equities, but we stuck with our discipline. We had planned to do some of this before the tragedy, and that made us realize how important it is that we review these matters. We doubt major changes will come from it, but we want to see if it's still appropriate to stick with our 75% equities, 20% bond, 5% real estate allocation."
* An asset allocation study of the $6 billion pension plans of General Dynamics Corp., St. Louis, led the company to add equities to its $4 billion U.S. government plan, which had been invested 100% in a long-duration fixed-income strategy. The study showed the mix should be changed to 60% equities, 40% bonds, and the bonds were put into shorter duration instruments. The change "was in response to the falling equity prices after the events of 9-11," said Charles Walbrandt, president of Fiduciary Asset Management, St. Louis, the plan's consultant.
* The $200 million endowment fund of Drew University, Madison, N.J., expects to complete its asset allocation study in the second quarter, said Jeff Balog, associate treasurer. "We do them periodically, and this market might have caused us to move a little faster," Mr. Balog said. "We want to be sure we're well positioned to satisfy the future operating needs of the university. If the markets go through a prolonged decline, there could be issues."
* At the $15 billion pension fund of E.I. du Pont de Nemours & Co. Inc., Wilmington, Del., the staff is debating whether to conduct an asset allocation study later in the year, said Paul Bosse, portfolio manager. "We normally do them every three to five years, and the last one was conducted between 1999 and 2000. After that one, expectations were ramped down from previous years, but we still have a surplus," Mr. Bosse said.
* Staff at the $175 million endowment of the University of New Mexico, Albuquerque, also is debating whether to do a study, because its consultant recommends it review each asset class in detail every other year, a spokesman said. The endowment also had planned to add private equity, but for now that is on hold.
Many pension plans review their allocation every year and do fine-tuning as needed. That is the practice at American Airlines Inc., Fort Worth, Texas, said William Quinn, president at AMR Investment Services Inc., which manages the $5.3 billion pension plan.
"A lot of people are looking at their asset allocation now, because the market has been down and they want to figure out how they can reach their assumptions. In many cases it means changing their allocation," Mr. Quinn said.
In addition to the poor market, Mr. Quinn believes the fact that billionaire investor Warren Buffett discussed actuarial assumptions in a Fortune magazine article earlier in the year has heightened interest in the subject. "Mr. Buffett said that with interest rates at 5% and the stock market returning only 6% to 7%, pension funds are not going to be able to make the average assumption, which is 9.5%," Mr. Quinn said.
He added American believes it can reach that mark with the addition of private equity and emerging market investments. American is keeping emerging markets at 5% of assets and adding two percentage points a year to private equity, which is now at 6% of assets and targeted to reach 10%.
John Ilkiw, director global consulting practices at Frank Russell Co., Tacoma, Wash., listed key questions pension funds are asking:
* Should we sell some equities and add more fixed income if equities won't add the same premium as in the past?
* Can hedge funds help us get to our goals?
* Is this the time to get into private equity, and what is its premium over public equities?
* Should we immunize returns and lock them in with a risk-averse strategy?
"At the end of the day, we make them realize there is no asset mix policy that will remove the need for higher contributions. Even with a 100% equity portfolio in a period of zero inflation, there is no combination that will get you the double-digit returns you had in the past decade. Pension fund managers will have to tell their trustees that they can't deliver it and that they will have to lower expectations to 5%," Mr. Ilkiw said.