Lingering shadow of 2018’s debacle hurts fund growth

Assets of the 1,000 largest U.S. retirement funds increased to $11.32 trillion in the year ended Sept. 30 at a slower pace — 2.9% — than in 2018 when assets grew by 6.4%, due to the lingering effect of poor market performance in the fourth quarter of 2018.

Over the five years ended Sept. 30, asset growth of the combined defined benefit and defined contribution plans of the 1,000 largest retirement funds was 25%, lagging the 31.8% increase over the same time frame ended Sept. 30, 2018, results of Pensions & Investments' annual survey showed.

Defined benefit plans within the top 1,000 funds were up 2.2% for the year to $7.06 trillion, or 62%, of total universe assets. Defined contribution plan assets were up 4% to $4.26 trillion as of Sept. 30.

Among the 200 largest retirement funds in P&I's universe, growth of DC plan assets continued to outpace that of DB plans in both the one- and five-year periods ended Sept. 30.

Assets managed in DB plans by the top 200 funds totaled $5.59 trillion, up 2.5% for the year and up 17.7% for the five years ended Sept. 30.

In contrast, aggregate assets in the DC plans of top 200 retirement funds increased by 4.6% to $2.58 trillion in the year ended Sept. 30 and by 44.4% over the prior five years.

The vast majority — 166 — of the 200 largest retirement funds in P&I's universe experienced positive asset growth in the year ended Sept. 30, but only 22 saw assets rise at least 10% in the year.

The pace of growth slowed for both DB and DC plans in P&I's top 200 universe compared to prior years.

As of Sept. 30, 2018, assets of the top 200 DB plans rose 4.4% compared to the previous year and were up 22.4% over the previous five years. Assets managed in top 200 DC plans increased 10.7% in the year ended Sept. 30, 2018, and 53.5% over the five-year period.

Lower aggregate growth rates among the largest U.S. retirement funds were largely performance-related, thanks to sharp market declines in fourth quarter 2018, when the S&P 500 index fell 13.5%, one of the worst declines since the financial crisis, sources said.

P&I estimated that the top 1,000 U.S. retirement plans experienced a collective performance-related loss of $764.9 billion in their DB and DC plans in the fourth quarter of 2018, which sources said affected asset levels overall in the year ended Sept. 30.

P&I's choice of Sept. 30 for one-year data collection for retirement fund assets provides a good example of period-dependent performance and its impact on asset growth, said Steven J. Foresti, chief investment officer at Wilshire Consulting Inc., Santa Monica, Calif.

"In the fourth quarter 2018, the big culprit was the market. There were large sell-offs in October and December, including on Christmas Eve. It was brutal," Mr. Foresti said.

He stressed that "one bad quarter among four made a massive difference in the performance of retirement funds over this period. The losses dug a big hole for many funds. Even with great performance in 2019, plan sponsors still were working off the losses as of Sept. 30," Mr. Foresti said.

Aside from fixed income, returns of major market indexes in the year ended Sept. 30 were lower than those produced the prior year.

The Russell 3000 index rose 2.92% for the year ended Sept. 30, significantly lower than the 17.57% return of the index the prior year. Over the same period, the S&P 500 index returned 4.25% compared to 17.9% the prior year. The MSCI ACWI IMI ex-U.S. equity index was down 1.84% compared to a 1.79% increase a year earlier.

The Bloomberg Barclays U.S. Aggregate Bond index was up 10.3% for the 12 months ended Sept. 30 and was down 1.2% the prior year.

The ranking of the three largest retirement funds remained unchanged based on combined DB and DC plan assets as of Sept. 30:

Federal Retirement Thrift Investment Board, Washington, remained in the top position with DC plan asset growth of 3.8% to $601 billion.

California Public Employees' Retirement System, Sacramento, held on to second place with asset growth of 2% to $384.4 billion, 99.5% of which is in the system's DB plan.

California State Teachers' Retirement System, West Sacramento, experienced growth of 5.7% to $243.3 billion, 99.5% of which is in the system's DB plan.

The three largest corporate retirement funds based on total DB and DC plan assets remained the same as in the prior year, but Chicago-based The Boeing Co. displaced AT&T Inc., Dallas, to take the No. 1 spot:

• Boeing's assets rose 4.7% to $129.5 billion, with 51% in the firm's DC plans in the year ended Sept. 30.
• AT&T's retirement plan assets were up 1.2% to $125.6 billion, with 54% in DC plans, securing the second-place ranking.
• International Business Machines Corp., Armonk, N.Y., accrued asset growth of 2.4% to $105.7 billion to remain the third-largest corporation plan, with 51% of assets in its DC plans.

Over the one-year period ended Sept. 30, the aggregate asset mix of the DB plans in the top 200 list did not change dramatically, except U.S. stock was down 2.4 percentage points to 22.5%.

Defined contribution sponsors among the top 200 retirement plans saw a more dramatic decline of 3.4 percentage points in the aggregate allocation to U.S. equity to 39.6% in the as well as an increase of 2.2 percentage points to 23.5% for target-date funds.

A deeper dive into P&I's data based on actual aggregate-dollar allocations by the defined benefit plans in the top 200 over the one- and five-year periods unveiled movement out of equities into fixed income and continued movement into passive strategies from active approaches.

DB plans of the 200 largest retirement funds reduced their allocation to actively managed U.S. equity by 19.7% to $325.1 billion in the year ended Sept. 30, a drop of 22.8% over the five-year period. Investment in passively managed U.S. equity strategies was up 2.7% in the year to $621.7 billion and increased 7.9% over five years.

"There is general dissatisfaction with equity as an asset class as investors continue to worry about equity risk in this late-market cycle. It's not a new trend," said Jeffrey MacLean, CEO of investment consultant Verus Advisory Inc. Mr. MacLean is based in the firm's El Segundo, Calif. office.

However, he added that "there is a fair amount of regret from plan sponsors who missed out on strong returns of the S&P 500 in 2019," noting that the S&P 500 returned about 31% in the calendar year.

During the year ended Sept. 30, several large retirement funds moved significant capital to passive equity strategies from active approaches.

The New Jersey Division of Investment, Trenton, which manages the $78.5 billion New Jersey Pension Fund, eliminated its $24.1 billion actively managed U.S. equity portfolio and moved $22.8 billion to passively managed domestic stocks.

Fund officials also decreased the fund's actively managed international equity allocation by 25.8% to $2.6 billion and increased the allocation to passive international equity by 9% to $11.4 billion.

The rationale for the shift was performance-related, according to the 2019 annual report of the New Jersey State Investment Council, which oversees management of the pension fund.

Deepak D. Raj, chairman of the council, said in the report that the 6.3% performance in the fiscal year ended June 30 trailed the 7.1% return of the fund's benchmark primarily because the fund's domestic equity portfolio underperformed the S&P 1500 benchmark.

"In the current market, it is difficult to generate market-beating returns on large pools of capital. The division recognized this and moved decisively to a passive ... portfolio for domestic equities. The move toward a passive portfolio was essentially completed in September 2019. Not only does this make it less likely that we will miss market opportunities, it also frees up division resources to be applied to other asset classes," Mr. Raj said.

By comparison, assets in actively managed U.S. bonds by top 200 DB plans increased 6.2% to $802.9 billion in the year ended Sept. 30, up 26.3% from five years ago.

Aggregate assets invested in passively managed U.S. bonds by large U.S. DB plans still are low compared to actively managed bonds. As of Sept. 30, the top 200 DB plans had an aggregate $138 billion invested using passive strategies, up 5.6% compared to the prior year but down 0.7% from five years ago.

Wilshire's Mr. Foresti said he suspects corporations moving more assets into liability-driven investments were the source of much of the strong growth in fixed income by defined benefit plans.

Assets identified as being in LDI strategies were up 16.7% to $109.8 billion for the year ended Sept. 30 and up 19.1% over five years.

Factor-based equity strategies also saw strong year-over-year growth of 159.4% for a total of $99.6 billion, Mr. Foresti noted. P&I did not track factor-based equity strategies, also called smart beta, five years ago.

"Investment in smart-beta strategies really is part of the move by asset owners to passive management from traditional actively managed approaches. Many smart-beta strategies essentially are passively managed and offer similar lower fees and tracking error," Mr. Foresti said.

CalPERS accounted for the vast majority of growth in factor-based equity strategies, with a 280.2% increase to $72.4 billion.

Another area of growth within the universe of the 200 largest U.S. retirement funds was internal management, with assets rising 9.4% to a total of $1.42 trillion in the year ended Sept. 30, an increase of 40.2% over five years.

CalPERS retained the first-place position with $286.4 billion of internally managed DB plan assets as of Sept. 30, up 17.1% from the prior year.

CalSTRS moved to second with internally managed DB plan assets up 10.4% to $114.7 billion, replacing the $215.4 billion New York State Common Retirement Fund, Albany, which dropped to third place with a 1% decrease to $110.9 billion.