After scary start, year ends well for world's pension funds

Double-digit performance across most equity markets buoyed 2012's estimated average investment return for pension funds in six major markets, providing some respite from the previous year's pounding.

“Sentiment was relatively negative (particularly during the first half of 2012), but the year turned out to be quite a good year for investors,” said David Carruthers, principal at Mercer in Melbourne, Australia. “Markets actually did pretty well, and even better if you consider the low-interest-rate and low-inflation environment.

“In general, it was hard to find an asset class in which returns were negative for the year. Pretty much every single asset managed a positive return.”

U.S. pension funds returned an estimated 12.4% on average for the year ended Dec. 31, compared with 1.4% the previous year, according to data from BNY Mellon Asset Servicing. Both U.S. equities and non-U.S. equities helped to bolster pension funds during the year, and fixed income and alternatives also generated positive average returns.

While the year brought about investor confidence of a more sustained recovery, it was also marked by choppy waters. Within the BNY Mellon U.S. Master Trust Universe, for example, the median return was 7.1% for the first quarter and -1.5% for the second quarter. The third quarter was up, with a median return of 4.6%, and the fourth quarter flattened with a 1.9% median return. BNY Mellon's data are based on actual returns for the first 11 months combined with estimates for December.

“2012 was a bit of a roller coaster,” said John Houser, vice president and manager of performance and risk analytics for BNY Mellon in Seattle. “What we saw was that intervention by (the U.S. Federal Reserve) and the (European Central Bank) really made a difference in boosting (investor) confidence.”

Fundamentals also lifted markets, especially in the U.S., Mr. Houser said. In 2012, U.S. housing values increased for the first time in six years, and the unemployment rate dropped to 7.8% by Dec. 31 from 8.5% a year earlier. The U.S. “re-elected a president and resolved the fiscal cliff issue, at least for now,” Mr. Houser added. Furthermore, investors “thought that the eurozone problem was being relatively contained.”

The Russell 3000 index returned 16.4% for the year while the MSCI Europe Australasia Far East index rose about 16.9% on a total-return basis. The MSCI World index returned 16.5% in U.S. dollar terms, while the MSCI Emerging Markets index rose 18.6% in U.S. dollar terms.

“Almost all equity markets (globally) performed strongly,” said David Cullinan, vice president and head of performance consultancy at State Street Investment Analytics, Edinburgh. “One of the key stories for 2012 will be that those with (relatively) large equities exposures would have done well.”

In fixed income, the Barclays Capital U.S. Aggregate Bond index increased 4.2% for the year ended Dec. 31. The Barclays Capital Corporate Investment Grade index returned 9.8%, while the Credit Suisse High Yield index added 14.7% during the same period.

While hedge funds didn't lose money, on average, they didn't make as much as equities or bonds. The HFRX Global Hedge Fund index gained 0.92% for the year ended Dec. 31. Year-end 2012 figures for the Cambridge Associates LLC U.S. Private Equity index were not available, but in the year ended Sept. 30, the index returned about 15%.

As a result, pension funds in most major markets also gained. In Japan, the world's second largest pension market, the estimated average pension fund investment return was 10% in 2012 compared with -2.7% in 2011, according to Russell Investments. U.K. pension funds benefited from an average 8% estimated return in the year ended Dec. 31, 2012, compared with 3.6% the previous year, according to State Street Investment Analytics.

U.K. equities gained about 13% for the year ended Dec. 31, while long-dated U.K. government bonds added about 3% — the same rate as inflation for the period. With an average equity exposure of about 62%, many U.K. local authority funds enjoyed returns above 10% in 2012, Mr. Cullinan said. Corporate defined benefit plans, on the other hand, averaged a 37% allocation to traditional equities.

Australian pension funds averaged 12.5% in estimated investment returns for the year ended Dec. 31. In 2011, the average return was -2.1%, according to Mercer.

Canadian pension funds averaged a total return of about 9% for the year ended Dec. 31, compared with the 1% of 2011, according to Russell Investments. Canadian stocks were among the weaker performers globally, with the S&P/TSX Composite index returning 7.2% for the year.

The Canadian stock market is dominated by three sectors: energy, which comprises about 26%; financials, which account for about 31%; and materials, which total about 20%.

“The three sectors together make up about 77% of the (Canadian) equity market,” said Bruce Curwood, director of investment strategy at Russell Investments in Toronto. “Oil prices fell this year, so the energy sector was slightly down. Materials also performed poorly, but financials helped to offset losses by rising 17.6%. That's why the Canadian stock market lagged equity returns in the rest of the world, which tended to be in double digits.”

In Switzerland, pension funds gained an estimated average of 6.3% in 2012, or 6.9 percentage points above the -0.6% average return from the previous year, according to data compiled by Towers Watson & Co. for the Swiss Pension Fund Association.

“Swiss equities did particularly well, and the allocation to (Swiss) equities does tend to be about 10% or more,” said Edouard Stucki, senior investment consultant at Towers Watson, Zurich. “The Swiss equity market is biased toward consumer growth and financials, both of which performed well in 2012. In part, the (Swiss National Bank's) policy to hold the exchange rate between the Swiss franc and euro stable helped exports and manufacturing.”

However, “one swallow does not make a spring,” Mr. Stucki added. Since data began being collected in 2000, the average annualized return for Swiss funds is about 1.3%.

Three major concerns from 2012 will continue to loom in 2013, State Street's Mr. Cullinan said. In the U.S., government indecision over the nation's debt ceiling will continue to affect markets. Growth concerns in China remain uncertain. “Perhaps the biggest unknown remains what will happen to the eurozone,” Mr. Cullinan added. “Market conditions remain very challenging.”

As a result, pension funds are continuing to reduce risk, particularly by diversifying into alternatives and away from a domestic bias, consultants said. In Japan, for example, pension funds lowered the domestic equity weighting to an average 11% as of Sept. 30, according to Russell Investments, from 14% as of Dec. 31, 2011. During the same period, allocations to non-Japanese equities investments increased by an average of two percentage points to 18%. Alternatives, particularly hedge funds, also increased two percentage points, to an average 13% of total assets as of Sept. 30.

“Whether this movement (away from domestic equities) could stop depends on whether the substance of the Japanese economy could improve or not,” said Konosuke Kita, director of consulting at Russell Investments Japan Co. Ltd., Tokyo.

In December, the Japanese parliament's election of Shinzo Abe as the new prime minister injected renewed confidence in Japan's capital markets. However, Mr. Kita said, Mr. Abe's pro-stimulus policies to tackle weak growth and chronic deflation “could also bring rising government liabilities, which could cause chaos.”

Data Editor Timothy Pollard contributed to this story.