The 1,000 largest U.S. retirement plans grew 8.4% in the 12 months ended Sept. 30, Pensions & Investments' annual survey shows. This lags previous growth rates, but isn't cause for alarm.
"What's not to like?" asked Carl A. Hess, practice director, Americas, for Watson Wyatt Investment Consulting, New York. He noted assets increased, while liabilities fell as interest rates rose.
With equity markets continuing to climb during the final quarter of 2006 — when the Russell 3000 domestic equity index gained 7.1% — the new year is off to a stellar start as well, pension consultants said.
Fixed-income allocations rebounded despite unspectacular returns for bond indexes. Consultants said this is evidence that corporate pension executives are grappling with thorny problems related to last year's Pension Protection Act and looming accounting changes that will make pension shortfalls a line item on corporate balance sheets.
For the year ended Sept. 30, 2006, assets of the largest 1,000 U.S. retirement plans rose 8.4% to $6.488 trillion, following gains of 12% a year earlier.
Assets of the 200 largest U.S. retirement plan sponsors, meanwhile, climbed 8.6% to $4.91 trillion, following gains of 12%, 11% and 15% in the prior three years.
But plan sponsors also reaped benefits from the rise in long-term interest rates during the year. All other things being equal, the 50-basis-point rise in 10-year U.S. Treasury yields over the survey period would serve to reduce liabilities by several percentage points, said David Hammerstein, principal and chief strategist with Pittsburgh-based pension investment consultant Yanni Partners.
For the latest P&I survey, defined contribution assets of the top 200 sponsors grew at a faster pace than defined benefit assets, but the latter still account for the lion's share of the assets: just less than 80% of the total. For the year ended Sept. 30, the group's DC assets jumped 9.3% to $1.042 trillion, while DB assets rose 8.4% to $3.869 trillion.
Defined contribution assets of the top 1,000 climbed 9.5%, outpacing the 8% gain of their DB assets.
On a market-adjusted basis, assets of both the largest 200 and 1,000 funds declined by 1.3% and 1.4% respectively.
Aggregate asset allocation numbers showed some recent trends continuing, with domestic equity claiming a receding chunk of overall portfolios while international equities and alternative asset classes loomed larger.
As of Sept. 30, domestic equity accounted for 43.1% of the average defined benefit plan in the top 200, down 1.8 percentage points from the year before.
The share of international equities stood at 18%, up 0.3 percentage point, while the "other" category, which includes hedge funds, rose 0.6 to 2.3%; private equity edged up 0.1 point to 4.1%; and real estate equity added 0.2 point to 4.1%.
Hedge fund investments reported by defined benefit plans came to $50.5 billion, up 69% from the year before. While investments in hedge funds of funds rose a strong 63% to $27.4 billion, direct investments in single-strategy hedge funds climbed even faster, up 76% to $23.1 billion.
Much of the rise in asset allocation figures for international equities, real estate equity and private equity could be accounted for by market appreciation. For the 12 months through Sept. 30, the Morgan Stanley Capital International Europe, Australasia, Far East index jumped 19.7% and the NCREIF Property index advanced 17.6%. While private equity returns for the period have not yet been released, for the year ended June 30, the asset class returned 22.5%, according to Thomson Venture Economics/NVCA.
By contrast, the 1.1 point rise in fixed-income allocations to 25.5% suggests a conscious policy allocation by corporate sponsors looking to better match their assets to their liabilities, said Yanni's Mr. Hammerstein. The Lehman Aggregate bond index rose 3.7% during the period.
The survey's breakdown of allocations by type of plan sponsor lends credence to that view. While fixed-income allocations by public and union defined benefit plans held steady or declined slightly during the survey period, allocations by corporate plans jumped 2.9 percentage points to 26.5%.
That marks a reversal from the prior three years. With equity markets rebounding between 2003 and 2005, corporate fixed-income allocations had tumbled 3.1 percentage points, 0.4 point and 1.4 points, respectively.
The recent boost in corporate bond allocations "may be the tip of the iceberg," as the Pension Protection Act and looming Financial Accounting Standards Board rule changes make pension fund volatility an "up-close-and-personal" issue for corporate executives, said Watson Wyatt's Mr. Hess.
Elsewhere, union funds — often seen as behind the curve in diversifying their portfolios — logged some of the biggest asset allocation shifts to alternative strategies from domestic equities. The aggregate union allocation to domestic equities dropped 3.9 percentage points to 46%, while allocations to the "other" category jumped 1.7 points to 1.9% and international equities rose 2.9 percentage points to 10.6%. Smaller increases also showed up in the funds' real estate equity (5.1% vs. 4.4%) and private equity (1.7% vs. 1.3%) allocations
Jack Marco, chairman of Marco Consulting Group, Chicago, said among his firm's union clients with more than $1 billion in assets, the shift to strategies such as real estate, hedge funds and private equity has been even more dramatic than the survey's averages.
For the coming year, consultants said corporate plans will be the ones to watch. All the details about investment returns for the latest year are being "overshadowed by the implications of the Pension Protection Act," with a moment of decision approaching for corporate plan sponsors, said Alan D. Biller, the president of Menlo Park, Calif.-based Alan D. Biller & Associates Inc.
The regulatory changes afoot are heralding the moment when "truth in pension funding" becomes the rule. There may be a flurry of changes in either investment structure or plan provisions as companies get ready for 2008, especially among sponsors facing "endangered or critical status" of falling below 80% or 60% funding respectively, Mr. Biller predicted.
Other highlights from the 2006 P&I survey include:
•The aggregate asset mix for the top 1,000 U.S. DB plans showed domestic equity with 43.7%, down 1.6 percentage points; domestic fixed income with 25.4%, up 0.5 point; international equity and international fixed income both unchanged at 16.8% and 1.2% respectively; cash at 1.6%, up 0.2 point; private equity unchanged at 3.6%; real estate equity at 3.9%, up 0.2 point, mortgages at 0.3%, down 0.5 point; and "other," at 3.5%, up 1.2 points.
•The survey suggests that size has its advantages, with the largest 100, 50 and 25 sponsors, respectively, posting gains of 8.7%, 9% and 9.3%.
•The survey showed very little change among the funds' market share, with public funds accounting for 54.3% of the overall assets of the largest 200 sponsors; followed by corporates with 35.2%; miscellaneous funds, with 8.1%; and union funds with 2.4%. A year earlier, the respective percentages had been 54.1%, 35.4%, 8% and 2.5%.
•The defined benefit plans among the 200 largest retirement funds reported $1.15 trillion in internally managed assets, an increase of 2.2% from a year earlier.
•For the 12 months, defined benefit assets invested in high-yield bonds dropped 6.7% to $50.3 billion.
•The defined benefit plans in the top 200 also reported $51.8 billion in Treasury inflation-protected securities, $74 billion in overlay strategies and $32.7 billion in portable alpha strategies — all new categories in this survey.
•The domestic equity managers most used by top 200 defined benefit sponsors were Barclays Global Investors, with 56 mentions, followed by State Street Global Advisors and Wellington Management Co. LLP, with 31 each. The most used domestic fixed-income managers were Western Asset Management Co., 38; BlackRock Inc., 34; and Pacific Investment Management Co., 32. The most used international managers were Capital Group, 43; BGI, 35; and AllianceBernstein LP, 31.
• On the defined contribution side, the most-mentioned investment managers overall were Vanguard Group Inc., 81 mentions; Fidelity Investments, 80; and SSgA, 64. Equity leaders were Vanguard, Fidelity and BGI; mentioned the most for fixed income were PIMCO, Vanguard and Fidelity; and for international equities, Capital Guardian, Fidelity and SSgA.
(updated with correction)
