U.S. pension fund executives expect to navigate a recession by the end of 2023, but while the market return environment is set to remain challenging, they see opportunities re-emerging in fixed income.
While they are unsure of just how challenging, they are convinced of one thing: a recession almost certainly looms in the coming year.
"My crystal ball is a bit cloudy," said Christopher J. Ailman, chief investment officer at the $307.2 billion California State Teachers' Retirement System, West Sacramento, in a phone interview. "I'm always reminded of the works of Howard Marks. It is virtually impossible to make predictions, especially ones about the future. We should have a recession in '23. The question is: Is it severe? It is mild? As one of my peers said, if we do in fact have a recession, it is the most anticipated recession in four years. Everyone is expecting it, which means they can all be wrong."
The level of expectation is due to a rising interest rate environment that defines the coming year after well over a decade of near-zero rates, as the Federal Reserve took aggressive steps to turn the tide of inflation in this past year — steps that reached the Fed's latest action on Dec. 14 when the Federal Open Market Committee raised the federal funds rate to a range of 4.25% to 4.5% following its two-day meeting.
Paul M. Colonna, president and chief investment officer of Lockheed Martin Investment Management Co., said in a phone interview that the interest rate hikes have created the biggest inflection point he has seen in the marketplace in a long time. In his role, he oversees more than $30 billion in frozen defined benefit plan assets of Lockheed Martin Corp., Bethesda, Md.
"It opens up a lot of new avenues for investments that quite frankly were not that attractive for the past decade or so," Mr. Colonna said. "It's given us opportunities where ... you're talking about 5% or 6% yields on high-quality fixed-income assets, and that differential on our long-term assumptions on equity returns ... is as narrow as it's been in a very long time."
Mr. Colonna said it provides a great opportunity for Lockheed's pension fund portfolio not only to manage the risk but provide a return-generating income.
Corporate defined benefit plan sponsors have asked in recent years: "Do you hedge or do you seek returns?"
"Now we have the chance to potentially do both," Mr. Colonna said.
As a result, he said the portfolio is going to go more into long-duration fixed income. "That's a place we've obviously been active, but we're going to be more active. We're going to be allocating more dollars to high-quality investment-grade (fixed income)."