GREENWICH, Conn. - A wide gap has developed between pension funds' actuarial interest rate assumptions and their rate-of-return expectations in various asset classes, a new Greenwich Associates survey says.
The gap is particularly evident among corporate pension funds, where the current actuarial assumed rate of return of 8.8% is higher than the rate-of-return expectations for all but three asset classes - international equity, private equity and equity real estate. Yet together these three asset classes account for only 14% of the average pension fund's asset allocation.
The gap is significant because plan sponsors base their contributions on actuarial assumptions, and high assumptions usually result in smaller contributions. If the rate-of-return expectations exceed the assumed actuarial rates, that's often a sign that the actuarial assumptions are conservative and can be easily met. If return expectations are lower than the actuarial assumptions, that could mean plan sponsors will have to increase their contributions to their pension funds.
"If pension funds want to avoid having to make contributions to their funds, they're not going to do it with the rate-of-return assumptions they're building into their investment policies," said John Webster, a Greenwich consultant.
In the survey, "United States Investment Management-Market Characteristics Report," the expected rate of return for private equity is listed at 12.6%. "That's a big assumption given the rates of return we've seen on private equity," Mr. Webster said. "It looks like a tall order."
Public funds have a more modest actuarial assumption - 8.3% - but there is uncertainty there, too. Public fund rate-of-return expectations in international equity, 9%, and private equity, 13.5%, anticipate stronger performance levels than recent returns would indicate.
The survey also reports that total assets of pension funds, foundations and endowments decreased an average of 7.6% last year, the first loss in 10 years. Corporate pension funds and endowments suffered the most, losing 9% of their total value on average.
Based on funds interviewed, Greenwich projects a total market loss of $475 billion for 2001.
An unfortunate quarter
Mr. Webster pointed out that the third quarter of 2001, which ended just when Greenwich's interviewing began, "was the worst quarterly (investment) performance in 10 years." He noted most funds had the majority of their assets in equities, whose performance was decimated.
The report states that U.S. pension funds and endowments saw their exposure to domestic equities fall to less than half of their investible assets last year, the first time since 1996 that U.S. stocks represented that small a share of the average fund's assets. Domestic equities accounted for 49.5% of the average fund's portfolio, down from 52% in 2000.
Every year, Greenwich asks all U.S. pension funds and endowments and foundations with at least $100 million to participate in the survey. Of the 2,368 in the universe, 1,445 were interviewed for the survey, which was conducted in October and November. Greenwich creates estimates for funds whose officials refuse to be interviewed.
* U.S. corporations' 401(k) plans contain about $300 billion of their own securities.
* Pension funds are looking to increase their rates of return by investing in more exotic asset classes. Thirty-eight percent expect to make a significant contribution to hedge fund investments over the next 12 months; 29% expect to make a significant contribution to private equity. That concerns Mr. Webster. "Looking at private equity as the cure for the dilemma and having heroic assumptions about what the returns will be is dangerous," he said. "It could be a disaster for everybody."
* Public funds that offer defined contribution plans rose to 46% in 2001, from 39% in 2000.