Goldman says pension stock sales won’t create domino effect in market

NEW YORK — Pension funds are expected to sell about $10 billion in equities in the fourth quarter, but it should not lead to a significant sell-off in the equity markets, according to a report by Goldman Sachs & Co., New York.

The report, written by Joanne M. Hill, managing director and head of equity derivatives strategy, estimates that defined benefit pension funds now are 3.1%, or $65 billion, overweighted in equities. This level seems to be where plans are compelled to act, according to the report. Ms. Hill said the overweighting of equities relative to bond holdings is actually about $32 billion, because some plans don't rebalance.

"When you look at the numbers, if all pension funds were to rebalance, $32 billion would come out of equities," according to Ms. Hill. But she doesn't expect this to happen.

Although pension funds reached critical levels for rebalancing in August, many wait until a new quarter to implement their shifts, according to the report. Beginning this month, Ms. Hill expects to see more movement out of stocks into bonds, but offsetting trends lead her to be more cautious about the expected intensity of net selling.

"There's a lot of discretion here," she said. "If the market is strong there is less selling, but if the market is flat more funds would tend to rebalance."

The report said the rise in bond yields and debates on pension policy in Washington have taken some pressure off sponsors about their concerns over the funded status of their plans. Several plan sponsors have a strong conviction that interest rates may be going higher, according to the report.

This, coupled with the improving business conditions at their companies, has made sponsors reluctant to rush to rebalance out of stocks. So those pension funds with the flexibility to actively invest their assets may not change their overweighted equity status, the report said.

Ms. Hill said in talking to several pension officials whose funds were overweight equities, some said they were hesitant to rebalance because interest rates were rising and equities had good performance. However, the recent decline in bond yields and fall of equity prices might make pension funds more inclined to reduce their overweighted portfolios.

But "we don't necessarily expect a significant sell-off in the equity markets (even with pension fund outflows) because the retail flows into equities from mutual funds in the last couple of weeks have been very strong," said Ms. Hill. "It would offset the money coming out of pension plans."

According to the report, pension fund investors exhibited similar behavior in the late 1990s, being reluctant to shift out of their largest asset class — equities — when it was performing well.

Contributions also have been coming into many pension funds, and that money could be invested in the stock market, offsetting equity selling.

Overall, the report estimates that about $10 billion of equities were for sale from pension funds in the first two weeks of October. But this can be balanced by retail flows or investing contributions. Ms. Hill said that the first two weeks of a new quarter tend to be when most rebalancing and strategic changes in investments are made.

To calculate the numbers in the report, Goldman used an estimate over the last year of how much rebalancing is done each month. It uses a 60-40/equity-fixed income mix.

The report used the top 200 pension funds data from Pensions & Investments. The numbers were market-adjusted for the pension funds going forward.