Corporate funds surf equity wave to great returns

Corporate pension funds in seven of the world's largest retirement markets continued to ride the equity bull in 2017, producing another year of impressive returns.

The average return for pension funds in Australia, Canada, Japan, Switzerland and the U.S. were higher in 2017 than the year before. Returns for the Netherlands and the U.K., while still in positive territory, were lower than the year previous. They ranged from 13% in the U.S. to an estimated 4.3% average for Dutch funds.

Geopolitical dramas filled headlines again in 2017, but market volatility remained stubbornly low. Markets continued to grow with the MSCI All-Country World index returning 23.97% in 2017, following a 7.86% gain in 2016.

The highest average return, for U.S. corporate pension funds, came in at 13% compared to a 6.7% gain in 2016. Figures from Willis Towers Watson PLC and Wilshire Consulting both showed the funded status of corporate funds in the U.S. improved over the year.

WTW's figures show an improvement in funding ratios for the 389 Fortune 1000 companies that sponsor U.S. defined benefit funds to 83% at the end of 2017 vs. 81% at year-end 2016. Wilshire's numbers, covering funds sponsored by S&P 500 companies, show funding ratios improved to 85.4% as of Dec. 31, compared with 80.9% a year previous.

"It was a very good market in the U.S. from an equity market performance perspective," said Beth Ashmore, a senior retirement consultant at Willis Towers Watson based in St. Louis.

She said it is interesting to note that the funded status of U.S. plans had been "pretty steady" at the 81% mark in 2014 through 2016, but 2017 showed a "modest increase — that's definitely one of the factors being fueled by the stock market, and being addressed by some sponsors coming out and starting to make larger contributions to their plan." She also cited examples of sponsors choosing to increase contributions in response to market factors.

"I look at this (higher funding level) and say that's welcome news, good news, it means a lot of different things in terms of benefits for sponsors," added Ms. Ashmore, noting higher funding ratios mean a lower financial impact from pension funds on corporate balance sheets and lower Pension Benefit Guaranty Corp. premiums to pay. "But the question sponsors will be asking here is: 'Now what; what's next?'"

Steven J. Foresti, chief investment officer at Wilshire Consulting in Santa Monica, Calif., said the trend of derisking by U.S. plans has continued.

"Financially strong sponsors that have the financial wherewithal to make sizable contributions into their plan and meaningfully change the funded level with contributions have really accelerated that derisking and moved to more of a hedging type investment strategy. And the plans that don't have the ability to just write a check and improve funding overnight have taken on more of a glidepath approach — banking gains when (they have been made), bringing down the funding volatility when the gap narrows," he said.

Australia had the next highest average return. Figures from SuperRatings Pty Ltd. showed Australia's superannuation funds returned an estimated 10.5% in 2017, up from 7.2% in 2016.

The firm said performance was bolstered by local stock markets with the S&P/ASX 200 index rising 20.7% in 2017.

Canada also had a good year, with an estimated return of 9.7% for a typical pension fund with a 60% equity/40% bond portfolio, said Bruce B. Curwood, director, investment strategy at Russell Investments Canada Ltd., Toronto. That compares with 6.5% in 2016.

"The 8-year-old bull market continued its late-cycle advance as world GDP showed strength on the back of a rising, but still low, interest rate environment. Those factors, along with the promise of lower taxes in the (U.S.), helped fuel global financial markets," he said.

He said three further factors also bolstered returns: a continued rise in material and energy prices around the globe; a resulting 9.1% in the S&P/TSX index; and positive investment returns for Canadian bonds. Mr. Curwood said the FTSE TMX bond universe provided an investment return of 2.5%.

"In short, coming off a terrific year where Canadian stocks rose 21% in 2016, this was another good year for Canadian pension funds, as domestic markets showed positive returns and foreign equities substantially outperformed," Mr. Curwood said. "The latter has become a bigger factor as Canadian funds have continued to reduce home-country bias and diversify their portfolios globally."

For Swiss pension funds, the equity allocation was an important factor in 2017. Based on Pictet LPP index returns, funds with a 40% equity allocation returned 8.63%, while funds with a 25% equity allocation gained an average 5.81%, said Daniel Blatter, Zurich-based consultant at WTW.

"In general, pension funds in Switzerland had a great year from a performance point of view, with the minor exception of the month of July," said Mr. Blatter. For the first time since the global financial crisis, these funds have mostly "fully funded their fluctuation reserves and have changed to more defensive technical assumptions."

In 2016, Swiss funds returned an average 4.2%.

Japan was the final market of the largest seven that saw better returns in 2017 than 2016, with corporate funds in Russell Investments' universe returning an average 6.5%, up from 2.8% a year earlier.

Three important changes in 2017 made the difference, said Konosuke Kita, Tokyo-based consulting director for Russell. "People moved assets from Japanese fixed income to other asset classes such as hedged international fixed income, or conservative investors moved to cash," Mr. Kita said. Some investors looked to gain higher yields by taking credit risk through unconstrained fixed-income strategies, he said.

At the same time, Russell executives have seen a decrease in domestic equity allocations, but almost no change to international equity exposure. "Some moved assets to fixed income, while some shifted to real assets. And one-fourth of our clients introduced (a) portfolio insurance strategy on (the) equity portfolio" to provide downside protection.

Within that move to alternatives, allocations to hedge funds decreased slightly while private assets exposure increased, Mr. Kita added.

For the U.K. and the Netherlands, the remaining two retirement markets among the big seven, investment returns for corporate funds decreased from 2016 — although they remained in positive territory.

U.K. fund investment returns fell somewhere within a range of 5% to 10% said Phil Edwards, Bristol, England-based partner, global director of strategic research at Mercer Ltd. That compares with a 20% return for 2016.

Overall, it was probably "quite a benign year for pension schemes (with) unusually low levels of volatility compared to some of the prior years, and clearly equity markets went up a lot." The FTSE All-Share index gained 23.9% in 2017. He said U.K. pension funds have an average about 30% allocation to equities.

The rest of the portfolio, however, was "not all that interesting, with bond returns in the low single digits and better — but not as good as equity — returns for alternatives.

He added that many pension funds with derisking triggers would have gone through those levels in 2017, so "some gradual derisking will have taken place." He said funds probably will have moved through more triggers than in previous years, "given the nature of market movements."

Coming at the bottom of the 2017 returns table was the Netherlands, where pension funds produced an average 4.3% return, said Edward Krijgsman, principal and investment consultant at Mercer in Amstelveen, the Netherlands. That compares with 7.3% in 2016.

However, funding ratios increased to 109% from 102% in 2016, with risk assets performing well and contributing "positively," he said.

But a 14.15% appreciation of the euro vs. the dollar did not contribute positively, since pension funds had an average 50% currency hedge in place.

Dutch pension funds also saw continued consolidation. Over the past​ 10 years the number of funds has fallen to fewer than 250, from close to 1,000, Mr. Krijgsman said.​