What sparked the 1990s stock market bubble? U.S. pension funds are obvious suspects because they are large and have a reputation for putting short-term performance pressures on money managers. Did that performance pressure contributed to the bubble?
I believe U.S. pension funds, defined benefit and defined contribution, were part of a complex process that contributed to the bull market that became a bubble - but they had a lot of help.
There was no bubble in the late 1970s and early 1980s, though there was rapid growth of corporate pension assets and pursuit of performance by pension funds and their managers in that period, and the funds helped to lift the market out of its 1973-'74 nadir. Something more had to be at work in the 1990-'99 period.
Among these additional factors was the move into equities by the nation's public pension funds, many of them very large funds. Most public pension funds had very low equity exposures in the early 1980s. In 1985, public fund equity exposure was only 30.1% on average. By September 2000, it was 61.2% (excluding private equity). That represented a very large flow of dollars into stocks.
At the same time, corporate defined benefit pension funds also were boosting their average domestic equity exposures to 63.3% (excluding private equity) from 48.5%. And corporate 401(k) plans, which in 1985 were relatively small and heavily invested in guaranteed investment contracts, were large and 69% invested in equities by 2000.
These three sources of increased demand for stocks certainly helped lift stock prices during the late 1980s and 1990s. That rise in stock prices attracted additional demand, first from individual investors outside of their employer-sponsored pension plans. IRA equity exposures began to match those of 401(k) plans. Foreign investors were attracted by the rise in U.S. stock prices, and the strength of the U.S. economy and the dollar.
But what about the performance pressures? Didn't they play a role? Money managers have been complaining about pressure from pension executives for above average quarter-to-quarter returns for almost all of the 29 years I have been reporting on pension funds. Was anything different this time?
Yes. The stock market demanded earnings, and the CEOs and CFOs were determined to deliver them. Pension income was a source of earnings. Therefore, pension execs at corporate pension funds felt enormous pressure to deliver returns to maximize corporate pension income, or at least minimize pension expense.
In addition, the number of available defined benefit domestic equity mandates dropped because of the dramatic decline in the number of corporate defined benefit plans, along with declines in corporate pension fund cash flows and in the average number of managers used by large funds per dollar of fund assets.
The result was intensified competition among money managers for that smaller number of defined benefit assignments. Performance became even more critical to being retained or being hired. Growth stock managers, in particular, chased the highest-flying stocks and the latest IPOs to generate that performance. Individuals in 401(k) plans also sought the hottest funds in their plans' universes. Performance became even more critical for success in the mutual fund arena.
All of this was laid on top of the hype from Wall Street analysts and investment bankers, and the genuine strong performance of corporate America and the economy.
So pension funds did contribute to the bubble - but they had a lot of help from Wall Street, mutual fund companies, foreign institutions, and individual investors.