U.S. defined benefit plan executives waiting for long-term interest rates to rise are finding themselves underhedged and more susceptible to rate decreases, said a midyear review of corporate pension plans from Goldman Sachs Asset Management.
At the beginning of 2019, the report showed most investors thought 30-year government bond yield would rise to 3.51% from 3.02% in 2018. But the actual yield as of June 30 was 2.53%, a full 98 basis points below that estimate.
Mike Moran, GSAM's senior pension strategist and author of the review, said in a telephone interview that many of their clients have been waiting for rates to rise for a very long time. But the falling rates "just increases the value of the liabilities and has a depressing effect on funded levels," Mr. Moran said.
However, despite the fall in rates, the review estimates the aggregate funding ratio of U.S. corporate defined benefit plans rose to 88.5% at the end of June from 86.7% at the end of 2018 thanks to phenomenal returns, Mr. Moran said.
The estimated 6.6 percentage-point drop in that aggregate funding ratio as a result of actuarial losses in addition to a 1.7-point drop due to interest costs and 0.6 points in service cost were more than offset by a whopping 10.1 percentage-point rise thanks to asset returns. Contributions also accounted for a 1 percentage-point increase.
Despite the higher investment returns, Mr. Moran said sponsors are "nervous about everything."
"They're worried about 'what are future-looking returns going to be?' " Mr. Moran said. "I think they're worried about everything because a lot of asset classes look expensive, or rates are going to lower more. There's a lot of concern that sponsors have both on the asset and liability sides of the equation."
He also said that clients overall are acknowledging that forecasting interest rates is a "difficult thing to do." Mr. Moran says in the review that clients have talked more about using derivatives and leverage to increase hedge ratios without diverting capital from return-seeking assets.
Some of that activity is due to clients realizing that forecasting interest rates is clearly not a core competency, the review said.
The review showed that since 2014, estimates of how the 30-year government bond yield would land at the end of each year have all been too high.