Size matters in innovation,study says

GREENWICH, Conn. — Smaller corporate pension funds are falling further behind their larger peers in adopting new investment strategies, a new survey from Greenwich Associates shows.

Only 8% of smaller corporate plans surveyed by Greenwich are considering significant changes to their asset allocation over the next three years. That pales in comparison to large corporate funds, where 40% say they will make major changes; and endowments and foundations, where 60% are planning changes by 2010.

“Normally, small funds look to the big funds to see what they're doing. That doesn't appear to be happening,” said Rodger Smith, a managing director at Greenwich Associates who analyzed the results.

Smaller plans — defined in the survey as plans with assets between $250 million and $500 million — are also slower out of the gate to adopt liability-driven investment strategies.

Only 40% of smaller funds have discussed LDI with their investment consultants, only 20% have discussed LDI with their actuary or accountant and only 12% have talked to their existing managers about LDI strategies.

For plans with more than $500 million in assets, 52% of executives have discussed LDI with their consultants, 31% have discussed the strategy with actuaries or accountants and 38% had discussed LDI with their current investment managers.

Mr. Smith noted that small corporate pensions have been slow to move into alternatives, including hedge funds, private equity, real estate and venture capital, and have not made the significant shifts to international equity that larger plans have made. Mr. Smith is suggesting those small plans make the necessary changes to get exposure to assets classes that are not highly correlated to the U.S. equity market, where lower returns are expected over the next five years.

According to the study, small plans allocated 47.5% of assets to U.S. equity in 2007, 29.4% to fixed income, 14.5% to international equity, 2.6% to real estate, 0.6% to private equity and 2.6% to hedge funds; the remainder was categorized as “other.”

Greenwich data shows that large corporate funds allocated 39.6% to U.S. equity, 28.9% to fixed income, 20.2% to international equity, 3.3% to real estate, 3.8% to private equity, 2.9% to hedge funds and the rest to “other.”

Staffing is likely the main issue keeping smaller plans from making shifts in their portfolios.

“The reasons prompting larger funds to think about changes also apply to the smaller funds,” said David Hammerstein, chief strategist for Yanni Partners Inc., Pittsburgh, a division of GBS Investment Consulting LLC. “But these smaller organizations just don't have the management resources of the largest funds.”

Smaller plans also have been slower to adopt LDI strategies that match assets more closely to liabilities, though they should because the Financial Accounting Standards Board, Norwalk, Conn., will require companies to put their pension fund's funded status on their income statement by 2010 or 2011.

He speculated some smaller corporate pension funds probably haven't looked at LDI because the funded status of plans improved significantly over the past two years. The average funding ratio for the accumulated benefits obligations of small corporate plans increased from 99% in 2005 to 106% in 2007, according to the report.

“Pension funds have not been a problem area (for chief financial officers), but when mark-to-market accounting comes, it could be,” Mr. Smith said.

One thing that deters small plans from using LDI is that such strategies often use swaps to get the extended duration needed to match liabilities more closely.

“You have to have a robust back-office infrastructure to handle all the swaps,” said Francois Otieno, a senior investment analyst in fixed-income research for investment consulting firm Ennis Knupp & Associates Inc. Chicago. Mr. Otieno helps clients who are considering LDI strategies.

He said another deterrent is that small plans simply don't want to be the first to try LDI.

“It's a very complex undertaking. No one wants to be the first mover.”