Top 1,000 retirement funds tread water in 2011

Assets of the nation's 1,000 largest retirement plans eked out a roughly 2% gain for the tumultuous 12-month period ended Sept. 30, even as efforts to better position investment portfolios to withstand market volatility continued apace.

According to Pensions & Investments' latest annual survey, the combined assets of the top 1,000 U.S. retirement plans edged up 2.3%, or $148.6 billion, to $6.71 trillion. The largest 200 plans, meanwhile, saw their assets climb 1.7% to $4.965 trillion.

The modest gain for the top 1,000 followed the previous survey's 8% rebound from two years of declines — -5.2% for the year ended Sept. 30, 2009, and -13.1% for the year ended Sept. 30, 2008 — after and during the global financial crisis.

By any measure, the recovery of retirement plan assets from the economic and financial debacle of 2008 is looking pale when compared to the one that followed the bursting of the technology bubble at the start of the prior decade. Retirement plan assets enjoyed double-digit gains in four of the five years through September 2007, with the one exception — the 8.4% advance for the 12 months ended Sept. 30, 2006 — still stronger than anything seen so far this time around.

The latest tepid showing is, in part, a matter of timing, with the survey's snapshot of asset levels being taken at a post-crisis low point for capital markets. For the quarter ended Sept. 30, the Russell 3000 benchmark for U.S. stocks tumbled 15% and the Morgan Stanley Capital International All-Country World index plunged 17%, even as a collapse of 10-year U.S. Treasury yields to 1.92% from 3.16% during the same period was swelling the present value of pension liabilities.

Markets have recovered strongly since then, with P&I estimating a rebound in top 1,000 retirement assets of more than $476 billion from Oct. 1 through Jan. 31, 2012.

For the latest survey period, the Russell 3000 delivered a meager 0.55% gain for the year ended Sept. 30, while the MSCI ACWI suffered a 5.54% drop and the Barclays Capital Aggregate bond benchmark rose by 5.26%.

That market backdrop left overall pension assets treading water, with 60 of the Top 200 retirement plans reporting results that ranged from a 2% decline for the year to a 2% gain.

Continued efforts to reduce equity exposure in favor of greater allocations to alternatives strategies, and growing interest in liability-driven investing, were leading themes last year, said Kevin Turner, Seattle-based managing director of consulting with Russell Investments.

The year was actually a “tale of two halves,” with initial optimism among U.S. institutional investors being deflated by the debt ceiling fight in Washington, Standard & Poor's downgrade of its U.S. sovereign rating and the eurozone sovereign debt crisis, said Edwin Conway, a managing director with New York-based BlackRock Inc. and head of the company's more than $1 trillion institutional business in the U.S. and Canada.

The ripple effects of that loss of confidence included a sizable move into cash and continued moves out of active equities, in favor of hedge funds, real estate and private equity, Mr. Conway said.

P&I's survey results were consistent with that picture.

Of the $3.729 trillion in defined benefit assets among the Top 200 retirement plans as of Sept. 30, allocations to cash rose to 2% from 1.3% the year before, or up 60% to $64 billion.

Allocations to domestic equities, meanwhile, dropped 1.8 percentage points from the prior year to 27.2%, and international equity allocations fell 1.5 points to 17.4%.

Among non-traditional strategies, allocations climbed 1.4 points for private equity to 10%, 1.5 points for real estate to 6.6% and 1.2 points for hedge fund-focused alternative investments to 4.5%, a combined gain of 4.1 points for those non-traditional segments.

The rise in real estate allocations reflected a “change in mindset” that saw exit queues for big real estate strategies early in the year give way to “significant entry queues” of as much as $2 billion to $3 billion in some cases, noted James A. Callahan, an executive vice president and manager of the fund sponsor consulting group at San Francisco-based investment consulting firm Callan Associates Inc.

Mr. Callahan said the plunge in bond yields during the latter half of the year might simply have made the cash yields offered by real estate investments relatively attractive.

A number of investment consultants and money managers predicted that public pension funds increasingly will be the marginal source of allocations for those alternative strategies.

When it comes to alternatives investments, the stance of public plan sponsors, whose open-ended commitment to defined benefit plans leaves them willing to take on illiquidity risk, and corporate sponsors, which increasingly are emphasizing defined contribution plans, has “started to diverge markedly,” said Scott McDermott, a New York-based managing director with Goldman Sachs Asset Management's Global Portfolio Solutions Group.

Corporate sponsors, by and large, are “moving away from being total-return type investors,” and their goal of lowering risk — by better matching assets and liabilities over time — entails a dynamic approach that works against making sizable allocations to illiquid strategies such as private equity, Mr. Callahan agreed.

That divergence has yet to surface in P&I's data, which show private equity allocations rising 1.3 percentage points for both corporate and public DB plans, to 9.1% and 10.5% of their respective portfolios. Taft-Hartley union plans, the third segment broken out, showed a 0.9 point rise to 3.8%.

All three investor segments, meanwhile, saw their hedge fund-focused allocations climb, with corporate plans up 2.8 points to 6.9%; public plans up 0.8 points to 3.7% and Taft Hartley plans up 1.3 points to 7%.

The past year was an “exceptionally busy” one across all segments of the institutional market, noted Shane Clifford, a senior vice president and head of U.S. institutional business with hedge fund-of-funds heavyweight Permal Group Inc., New York.

Fully 70% of Permal's institutional client base “gave us additional money in 2011,” and the pipeline for 2012 is looking fairly attractive as well, Mr. Clifford said.

If the latest survey showed continued interest in alternative strategies, the other major theme cited by investment consultants and money managers - LDI - didn't show up in the asset allocation numbers.

Despite the more than 5% gain by core bond benchmarks for the year, the Top 200's defined benefit allocation to domestic fixed income slipped 0.9 point to 26.6%.

Even for the corporate DB segment of the Top 200, the principal audience for LDI programs, the allocation to domestic fixed income slipped to 36.5% from 36.8%, while domestic equities actually edged up to 21.9% from 21.2% — the opposite of what LDI-inspired flows would have done.

James Moore, managing director of Newport Beach, Calif.-based Pacific Investment Management Co. LLC's global liability-driven investments product management team and co-head of its investment solutions group, said rebalancing by corporate plans after equities plunged in the third quarter might account for those counterintuitive asset allocation shifts.

Mr. Moore said PIMCO saw more than $8 billion in net LDI-related inflows last year, but — before the third-quarter spike in volatility — the early pace of allocations had left him expecting more than $14 billion.

Russell's Mr. Turner said the apparent hiatus in shifts by corporate defined benefit plans out of equities and into fixed income is masking a considerable amount of pent-up demand and determination to push ahead with LDI programs, temporarily stalled by the drop in both funding levels and bond yields last year.

LDI was only one aspect of a complicated picture for institutional fixed-income allocations last year.

What to do with fixed-income allocations is “the No. 1 question” institutional investors are dealing with now, said John T. O'Shea, a managing director and institutional client adviser with J.P. Morgan Asset Management, New York. With the yield on the 10-year U.S. Treasury note below 2%, there's a growing consensus on giving bond managers more flexibility, whether it's with “duration, sector, geography,” Mr. O'Shea said.

The past year saw a growing conviction that benchmarking bond allocations to that old standby, the Barclays Capital Aggregate, isn't going to get investors “to the promised land,” even as the eurozone crisis forced them to rethink exposures they once took for granted, said BlackRock's Mr. Conway.

If LDI wasn't showing up in P&I's asset allocation numbers, market watchers said the strategy's influence could be seen in the relatively strong gains reported by corporate plans with LDI programs.

With long-dated Treasuries delivering a 35% return in 2011, any company with an LDI program that includes that type of exposure would have to be “pretty happy with their results,” said Douglas Hulsey, head of U.S. sales with Western Asset Management Co., Pasadena, Calif.

“If you had 30% of your portfolio in long government bonds, you probably did well,” enjoying perhaps 200 or 300 basis points of return above what a typical 60% equity/40% bond portfolio would have yielded, agreed Jeffrey Saef, Boston-based managing director, investment strategy and solutions, with BNY Mellon Asset Management.

Among corporate plans with LDI programs for P&I's latest survey, Target Corp. reported a 10.7% gain for its DB plan to $2.7 billion in assets as of Sept. 30; Hewlett-Packard Co. logged an 8.8% advance to $11.7 billion; and United Technologies Corp. rose 6.6% to $17.5 billion.

Money managers and consultants alike predict a pickup in LDI-related allocations this year.

Behind the scenes, a lot of plan sponsors are getting ready, and when their funded status improves, the shift to fixed income from equities will accelerate, Russell's Mr. Turner predicted.

BlackRock's Mr. Conway agreed: “Last year, there was a lot of talk about LDI, but there wasn't much implementation. This year, I think, will be different.”

There was a pickup in LDI-related activity as market conditions improved during the final quarter of 2011, and activity in January has “probably been as healthy as we've seen in a number of years,” PIMCO's Mr. Moore said.

However, GSAM's Mr. McDermott said a possible fly in the ointment, if too many investors are geared up to move in that direction, is that their buying of long-dated bonds could weigh on the long end of the curve, suppressing the kind of bounce in yields that could pull more of their brethren off of the LDI sidelines.