U.S. funds outperform plans in 5 countries

Buoyed by strong domestic and international equity markets, U.S. pension funds had the best return last year among six major pension markets.

With a median 13.7% return for 2006, U.S. funds nearly doubled their 2005 return of 7.3%, according to estimates by Callan Associates Inc., San Francisco. A year ago, the U.S. placed at the bottom of the six-country rankings.

Australian funds came in a strong second, with a 13.5% average return for corporate and industrywide pension funds in 2006, according to JANA Investment Advisers Pty. Ltd., Melbourne. In 2005, corporate pension plans averaged 13.6%, while industrywide plans gained 14.5%.

Canadian pension funds, one of the more consistent performers in the past two years, ranked third with a 13% investment return in 2006, compared with 12% in 2005, according to Russell Investment Group, Toronto.

In other major pension markets:

• U.K. pension funds gained a solid 10%, but the returns were about half that of 2005, when they chalked up an average 19.5%, according to WM Performance Services, Edinburgh. Contributing to the lower return were poor bond returns and currency exposure.

• Dutch pension fund returns were dragged down by negative bond returns. Dutch fund returns were estimated to be 7.2% in 2006, less than half of their 2005 performance of 14.7% in 2005, according to WM's office in Amsterdam.

• Japan fared the worst of the countries surveyed, with the average pension plan returning 5.3%, compared with 17.1% in 2005, according to Russell's Tokyo branch. Japanese funds were hurt by weak domestic stock market returns.

Worldwide, a general shift into global equities helped offset lukewarm returns in other asset classes. For example, Japanese pension funds now have an average foreign equity exposure of about 22%, compared with about 15% three years ago, according to Russell.

"The largest contribution this year has come from non-Japan equity, which returned 23.78% compared to Japan equity, which returned 3.02%," said Kaname Takahashi, consultant at Russell in Tokyo.

In the U.S., international equities averaged about 17% of total pension assets in 2006, compared with 15% in 2005. In Canada, domestic equity weightings have declined to about 25% in 2006 from about 30% a year ago, while overseas equity allocations have increased accordingly, said Jim Franks, director of consulting at Russell in Toronto.

U.S. pension funds collected hefty gains from robust market performances both at home and abroad. The Standard & Poor's 500 index returned 15.8% in 2006 in dollar terms while the Morgan Stanley Capital International Europe, Australasia, Far East index returned 13.8% in local currency terms. However, in dollar terms, the MSCI EAFE index surged to 23.5% for the calendar year.

The effect of the weak dollar is even more acute for stock investments in the eurozone. The MSCI Euro index returned 17.8% in local currency terms for the year ended Dec. 31, but jumped to a whopping 31.6% when reported in dollar terms.

"The currency impact is a major consideration this year," said Alastair MacDougall, executive director of WM in Edinburgh.

While the weak dollar pushed returns up in the U.S., it was a major culprit in dampening U.S. stock market performance for pension funds in other countries, particularly those in the U.K. and the Netherlands. For example, the S&P 500's 15.8% return was offset by a 12.3% decline in the value of the dollar against the pound and an 11.5% fall against the euro.

"Anxiety persists over the dollar among U.K. pension funds," Mr. MacDougall said. "Most U.K. pension funds do not hedge against overseas currency exposure, but that's changing. I think given what's happened with the dollar and the yen this year, more will be looking to better manage their currency exposure going forward."

European pension investments took another hit with a tumbling yen, which fell 13.1% against the sterling and 12.6% against the euro for the year.

While the MSCI Japan index grew by 6.1%, the average British and Dutch pension funds recorded negative Japanese stock performances in 2006, WM statistics show. And, at the same time that Dutch and U.K pension funds are being squeezed by currency movements, they've also experienced bond market returns that are "flat or negative," said Rob Van Boeijen, client manager at WM's Amsterdam office.

"For the first time since 1999, bonds showed a negative return of 1.7%" among Dutch pension funds, said Mr. Van Boeijen. He estimated the average Dutch fund's allocation to global fixed income is about 46%. He added the negative return is partly due to the dollar's impact on overseas fixed income, including U.S. Treasury securities.

In the United Kingdom, domestic conventional bonds returned 0.5% for 2006, with pension funds allocating about 12% of their total assets on average, according to WM statistics. Inflation-linked domestic bonds, which comprise another 8% of the total assets of the average U.K. pension portfolio, fared better, with a return of 2.6%. However, both asset classes returned below the annual inflation rate of 4% for 2006, according to WM estimates. About 3% of total assets were allocated to overseas bonds, which were also knocked by currency movements, returning a negative 6.6% in 2006.

Alternatives — including real estate, private equity and hedge funds — helped boost returns. The U.S. reported a more gradual increase in alternatives. Real estate weightings rose to 2.3% in 2006 from 1.7% in 2005, while other alternative investments slightly shifted to 6.4% from 6% of total assets, according to data from Callan.

Among British pension funds, real estate rose to 8% from 7%, according to WM. For the 13th consecutive year, real estate produced positive investment returns among U.K. pension funds, earning 17%. Allocations to other alternatives such as private equity, hedge funds and commodities increased to 3% in 2006 from 1% in 2005.

Real estate also dominated alternative investments in Australia. Allocations to real estate investments increased to 10% in 2006, up from roughly 8% the previous year. At the same time, Australian pension funds enjoyed returns of 16.1% for unlisted real estate investments and 34.1% for listed real estate investments.

David Holston, JANA Investment's executive director, added: "This (real estate) has been one of the key drivers of performance."