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Pension Funds

Fourth-quarter decline smacks pension funds in largest markets

Steven J. Foresti said despite derisking efforts, U.S. funds still were stung.

Corporate pension funds in the seven largest retirement markets around the globe bore the brunt of a difficult fourth quarter for equity markets.

Pensions & Investments' analysis of corporate pension funds in Australia, Canada, Japan, Switzerland, the Netherlands, the U.K. and the U.S. showed a range of estimated returns, from zero for Australia to -6.25% for the U.S.

Sources in each market said the fourth quarter of 2018 had an outsized impact on returns. The MSCI All Country World stock index lost 12.8% in the three months ended Dec. 31, with a calendar year loss of 9.4%. That compares with a 2017 gain of 24%.

Suffering most were U.S. corporate pension funds, with the estimated loss of 6.25%, according to Wilshire Consulting.

"Equities had a very difficult year, mostly in the fourth quarter," said Steven J. Foresti, chief investment officer at Wilshire Consulting in Santa Monica, Calif. "Even though many of these U.S. corporate plans have derisking and others are on a glidepath … the biggest impact is still coming from what equity markets are doing."

Mr. Foresti said 50% or more of equity allocations for U.S. funds are invested in the U.S. stock market.

The Russell 3000 index lost 14.3% in the fourth quarter, bringing overall 2018 returns to -5.2%. That compares to a 21.1% gain in 2017, when U.S. corporate pension funds returned 13% — which put them at the top of the table that year.

The return of volatility at the end of the year came after a 2017 that "was historically one of the most tranquil, calm, low-risk, low-volatility markets we've almost ever experienced," Mr. Foresti said. "It was no surprise that 2018 wouldn't repeat that calm story. That's not to say (2018) was an unusually volatile period — (it was) more close to normal — but it really felt like a wake-up or shock back to risk" simply because of a calm previous year.

"It's not that investors got complacent, but the further you go from being tested by markets and volatility, the less you appreciate what your true aversion to volatility really is, and understand the stress it puts on decision-making," he said.

While markets moved plenty, from a funding perspective there was no change just by considering year-end figures, Mr. Foresti said. U.S. corporate pension funds ended 2018 at just less than 85% funded — where they started the year.

But they did move during 2018, with funding levels almost hitting 92% midyear. "At the end of the year, with the large bear market territory sell-off in the fourth quarter, we saw essentially all of those gains given back," Mr. Foresti said.

Negative territory

Among the other six markets, not one achieved a positive return for 2018 — although Australia didn't go negative, either.

Even the superannuation funds were particularly affected by a difficult December, said Jeff Bresnahan, managing director, and Kirby Rappell, executive director at SuperRatings Pty Ltd. in Sydney.

They said the estimated monthly return for these plans in December was -1.6%, which followed a 2.2% return for the year to Nov. 30. For the calendar year, the median balanced superannuation fund, with 60% to 76% in growth assets, returned zero. That compares to a 10.7% gain for 2017. The S&P/ASX Total Return 200 index lost 8.2% in the fourth quarter and lost 2.8% in 2018. It gained 11.8% in 2017.

The pair said they have seen funds continue to reduce their domestic equity bias in favor of international equities, and allocations to fixed income have "moderated."

Annual returns also were crushed by the fourth-quarter market volatility for Canadian pension funds, with a 60/40 portfolio fund returning about -1.1%, said Andrew Kitchen, managing director, institutional Canada at Russell Investments in Toronto. In 2017, Canadian funds gained 9.7%.

This volatility "battered financial markets as geopolitical concerns escalated and signs of slowing global economic growth emerged. The year ended on a gloomy note, with major market indexes losing significant ground, some of them posting their worst year since the 2008 crisis," Mr. Kitchen said.

The S&P/TSX Composite Total Return index lost 10.1% in the fourth quarter and lost 8.9% for the calendar year 2018, compared with a 9.1% gain in 2017.

Canadian bonds provided much-needed stability against the increasingly volatile equity market thanks to a slight uptick in returns, Mr. Kitchen added.

Also in 2018, Canadian pension funds continued to reduce their home-country bias, moving further into global markets and diversifying alternatives, he said.

U.K. losses

The U.K. came in next, with corporate pension funds making an estimated loss of 1% to 2%, said Joanne Holden, U.K. chief investment officer in Liverpool, England, at Mercer. That is based on funds with an average asset allocation of 35% gilts, 25% global equities, 20% alternatives and 20% credit.

"A big theme for us last year was equity protection, and we have put in place about 12 billion ($15.3 billion) worth of notional equity protection," Ms. Holden said. That figure represented a big increase on previous arrangements, she said, although comparative figures were not available.

"You can imagine those clients that had that done before (the fourth quarter) were feeling quite comfortable, but I expect we will see more of our clients (implementing this strategy) as we go into 2019," she added.

The FTSE All-Share index lost 10.2% in the fourth quarter, was down 9.5% for all of 2018 and gained 13.1% in 2017.

Also affected by poor performance in risk assets — particularly in the fourth quarter — were Dutch pension funds, which lost an estimated 2.4% in 2018, compared with a 4.3% gain in 2017. Solvency ratios decreased over the year, with the average funding ratio falling to 103% at the end of 2018 vs. 109% at the start, said Edward Krijgsman, principal and investment consultant at Mercer in Amstelveen, Netherlands.

There were nuances among these corporate funds. "Because of the decrease in (interest) rates, pension funds with a relatively high interest rate hedge performed better than pension funds with a lower hedge ratio," said Mr. Krijgsman. A 5% gain for the dollar against the euro also contributed positively since the average currency hedge for Dutch funds is 50%. He said these funds on average have a lot of overseas exposure in portfolios.

Also last year, consolidation continued among Dutch funds, with the number of retirement plans falling to 226 as of the end of the third quarter from 231 at the end of 2017. Mercer expects this figure to decline further in 2019.

Japan funds fall

Behind Dutch funds were all Japanese pension funds, which Konosuke Kita, director, consulting at Russell Investments in Tokyo, said lost 3.38% in 2018. That compares with a 6.5% gain the previous year.

Corporate pension funds have been on a derisking journey, generally maintaining an equity allocation of 20% to 25% "with the intention to seek stable income return," while public funds have an average 50% equity allocation, taking "enough risk on a long-term point of view," he said. Corporate funds also have taken more interest in private debt, driven by the low-yield environment, he added.

And coming in with the second-worse returns were Swiss pension funds, producing an estimated return of -4.5%. The figure is based on an average fund with about 30% invested in equities. The loss compares to an 8.63% return in 2017.

Daniel Blatter, consultant, head of pension fund management Switzerland, and Michael Valentine, investment consultant, both at Willis Towers Watson PLC in Zurich, said the return was -4.5% for the calendar year 2018, using the Pictet LPP 2005-40 Plus index as a broad proxy. They added that Swiss corporate funds lost 4.5% for the fourth quarter alone.

"Thus returns were flat over the first three quarters of the year before a combination of various factors resulted in negative market sentiment and reaction," Messrs. Blatter and Valentine said.

Downward market moves were particularly damaging for funding levels of Swiss pension funds. Adding to the decline in equities was a decline in corporate bond-based discount rates, resulting in higher liability valuations. Global stock markets were affected by monetary policy and some moves to quantitative tightening from easing, geopolitical developments and hits to U.S. technology stocks.

"The small Swiss market, with its high concentration of large, global names (such as Nestle, Novartis and Roche) is not immune to these developments. With the Swiss National Bank sticking to negative interest rates, we also expect the ongoing general shift out of domestic bonds and cash to continue, as well as continued strength of the safe haven Swiss franc," added Messrs. Blatter and Valentine.