Pension executives will continue to rely on creative investing, higher contributions and pension buyouts or lump sums to make any improvements in funded status in 2013.
Markets won't likely offer much respite to underfunded pension plans globally, as experts see tepid investment returns and stagnant yields on bonds used to calculate liabilities in the year ahead.
“We've brought our (long-term return expectation) numbers down a little bit, but that's primarily an issue with the starting position” as most asset classes have rallied in 2012, said Michael Feser, managing director and head of quantitative research and portfolio management for J.P. Morgan Asset Management's global multiasset group, New York.
For example, annual return expectations for U.S. large-cap equities will fall to 7.25% in JPMAM's forthcoming capital market assumptions, down from 8% a year prior. Expected returns on international stocks are unchanged at 7.5%, while expectations for emerging markets stocks dropped to 9.75% from 10%.
“I fully think it will be a challenging year” for investments, said Stephen Wood, chief market strategist, North America, at Russell Investments, New York. Russell could not provide capital market assumptions for 2013, but Mr. Wood said perceived riskiness of markets will continue to depress yields on the safest government and corporate bonds used to price pension liabilities. “I'm not convinced there'll be tremendous change in that,” he said.
“Markets are the big uncertainty,” said Phil Page, client manager at fiduciary manager Cardano Risk Management BV, London. “In most scenarios, we think equities can go up from here (and) deliver 6% to 7% per annum returns over the next few years, but it might be quite a bumpy ride.”
Institutional investors in Europe, while being “cautiously optimistic for 2013,” do rate investment volatility as a major risk in the year ahead, according to an October survey by search consultant bfinance.
“Asset price collapse” and “asset price volatility” were among investors' biggest concerns for the year ahead: 85% cited collapse — and 80% cited volatility — as a significant risk, with 26% and 28% of respondents having plans in place to deal with a market crash or volatility, respectively, according to the survey of 54 primarily European institutional investors with combined assets of nearly $350 billion.
Meanwhile, investment experts do not expect the yields on bonds used to calculate pension liabilities to rise from very low levels for up to three years. And it's in the area of liabilities that pension funding has been hit the hardest.
Among U.S. plans, aggregate funded status fell three percentage points to 75% in the 10 months through Oct. 31, despite an equity rally of 14%, according to J.P. Morgan Asset Management.
Persistent rock-bottom interest rates and investor flight from volatile equity markets have pushed down returns on the safest assets, pushing up costs on derisking programs such as liability-driven investing. That's left pension executives searching for new ways to meet return expectations or lower funding shortfalls, such as pension buyouts and lump sum distributions, which will continue in 2013.