Despite a truly frightening March, funds ended year in great shape

Despite a roller-coaster ride in global markets as a result of the coronavirus pandemic — leading to some temporary but significant dips in funding levels — retirement plans ended 2020 with a decent set of investment returns.

Analysis of seven major retirement plan markets — Australia, Canada, Japan, the Netherlands, Switzerland, the U.K. and the U.S. — found that estimated returns for corporate plans varied from 3.5% for Australia's superannuation funds to 14% for U.S. pension funds, according to industry sources.

Equity markets plummeted in March as the COVID-19 pandemic and subsequent shutdowns to limit its spread bit hard. The S&P 500 index fell almost 35% through March 23.

However, while the drop caused momentary pain for pension funds — with some seeing 10 percentage points wiped off their funding levels as a result of the March turbulence — equities rallied hard through the rest of the year, finishing 2020 with a return of 18.39% for the S&P 500. And that helped funding levels to return close to the positions they were in at the start of the year — if not slightly above in some cases.

The turbulence led to rebalancing within these corporate plans, sources said, but also a lot of sleepless nights as sponsors were forced to watch funding levels and solvency ratios slide.

For the U.S., where corporate funds made an estimated investment return of about 14%, pension plans also struggled with their funding levels.

By Wilshire Consulting's measures, U.S. corporate plans on average came into 2020 funded at about 87%, dropping to around 80% at the height of the crisis in the first quarter. However, they were pretty much back up to around 87% by the end of the year, said Steven J. Foresti, Santa Monica, Calif.-based CIO and managing director.

Mr. Foresti said public plans ended 2019 about 74.8% funded, dropped to about 63% at the height of the pandemic — "a huge drop-off" — before recovering back and even improving to about 78.5% at the end of 2020.

Trading in credit was tough in particular and transacting was difficult and costly. "The order of the day in March and April was trying to manage rebalancing against that illiquidity and the cost of it," Mr. Foresti said. "It's a lot easier to say than to actually execute, and all these behavioral biases and risks come into play when you're buying something that's just fallen off the table and the future is uncertain. But to the credit of almost all our clients, they stuck to the plan" and rebalanced where needed.

The future, however, is less rosy. The main driver of the market recovery was government and central bank stimulus "in terms of trying to fill in the economic hole that was created," which lifted markets. But "we're now at a point where (we're) in a forward-looking environment, and you could argue we've pulled some of the returns forward," Mr. Foresti said. There are "very muted expectations" looking at what returns can give, even further up the risk curve. "While funding levels improved, I think the road ahead will be quite challenging," he said.

Employer contributions going forward "is another challenge. Depending on what pocket of the market you're in, the economic slowdown (and other elements) create some problems in terms of budgets" for the sponsoring employers.

There's been a "huge divergence" in the impact of the pandemic on corporations, which in turn "has a huge impact on the strength of the sponsor to make contributions. It's hard to make a high-level statement, but it obviously puts more stress on companies that find themselves in more impacted parts of the economy," Mr. Foresti said. "I imagine a pension sponsor that's an airline is probably having a very different conversation than a sponsor in the middle of the technology sector, making products or services that are making work-from-home life easier."

Canadian plans are also thinking about meeting future return requirements.

"As a result of the low expected yields available on bonds and a desire for more control of the funding risks, many plan sponsors are revising overall investment policy and conducting strategic reviews," said Andrew Kitchen, Toronto-based managing director, institutional Canada, at Russell Investments Canada. Common themes include a continued move away from domestic equities and into global and emerging markets; new asset classes such as private debt and infrastructure; and more fixed-income diversification, taking on more credit and on a global exposure.

These corporate pension funds also watched their funding ratios fall and rise again. The Russell Investments Pension Solvency index, which represents the solvency ratio of a hypothetical Canadian pension fund, dipped to 81% in March, but rebounded over the rest of the year and ended up at 98% — higher than the 94% funding ratio at the end of 2019, Mr. Kitchen said.

The typical 60/40 Canadian pension fund — with an asset mix of 20% Canadian equities, 40% global equities and 40% Canadian bonds — gained an estimated 10.5% in 2020. But a pension fund using longer-duration bonds — with about 15% in Canadian equities, 45% in global equities and 40% in Canadian long-duration bonds, would have gained about 12.5% last year, Mr. Kitchen said. That's because long bonds earned "an impressive" 11.9%, he said.

"However, pension health was tested due to falling fixed-income yields resulting from the spring market fallout in response to the pandemic," Mr. Kitchen said. "These lower yields provided significant liability increases that offset a significant portion of the asset returns achieved by most plans. We worked with many of our clients to actively rebalance their portfolios throughout the year."

The estimated return for Dutch pension funds was 8.2% for 2020, said Edward Krijgsman, a principal at Mercer Ltd. in Amstelveen, Netherlands. "The second half of February and the first part of March were the most difficult and showed the sharpest decreases in risk assets. Solvency ratios decreased sharply in the first quarter for Dutch pension funds" but recovered somewhat in the final three quarters as risk assets recovered. The funding ratio of the average Dutch pension fund fell to 100% at the end of 2020 from 104% the year before.

Dutch rules require pension funds to have a minimum solvency ratio of about 104% to 105%, although the Ministry of Social Affairs in the country adjusted these rules in 2019 to a 90% ratio to help in the transition to a new retirement system. The minister said in December that the 90% solvency ratio cutoff would also apply for the end of 2020, meaning only those corporate pension funds with a solvency ratio lower than that level would have to cut pension benefits.

Most Dutch pension funds kept to their policies of rebalancing when asset levels reach certain triggers. "Looking back with hindsight, that has been very positive — most decreased fixed-income portfolios at that moment, increased the equity portfolio to get back into the bandwidth (required by their investment policies)," Mr. Krijgsman said.

And then risk assets continued to rally through the end of the year, "so some in Q4 hit the upper bandwidth … and now are rebalancing the other way around — they sold some risky assets and proceeds were invested in the matching or fixed-income portfolio," he said.

U.K. corporate pension funds tracked by the Pension Protection Fund's 7800 index also saw wild swings in funding levels. The funds came into 2020 at 98%, dropped to 92.5% as of March 31, but recovered somewhat to 95.5% as of Dec. 31.

Many pension funds "have not (been) affected greatly by coronavirus. But some have seen worrying falls in funding ratios, combined with employers getting into difficulty" and at the same time carrying out actuarial valuations that require a renegotiation of employer contributions, said Charles Cowling, partner and chief actuary at Mercer in Manchester, England.

He estimated a U.K. corporate fund return of about 9% for 2020.

However, not all seven markets achieved returns approaching double digits.

Swiss pension funds in occupational pensions firm FCT's sample achieved a median return of 4.12%, said Daniel Blatter, key senior account manager in Zurich. These funds "are in a better position than expected when the crisis broke out and reached its maximum hit in March," he said.

The average Swiss pension fund ended 2020 with a coverage ratio of about 113.3%, Mr. Blatter said — up from about 109.5% to start the year. FCT executives estimate that funds saw almost 90 billion Swiss francs ($94 billion) in capital losses in February and March, with the funding level slipping below 100% on individual days and ending March at about 101.7%.

Global equities, real estate and Swiss equities made the biggest contributions to performance, "but also throughout all other main asset classes we saw a positive contribution to the 2020 performance," he added.

The speedy recovery in 2020 and positive returns mean "a lot of pension funds have done their homework and reduced technical interest rates used to discount the future benefits of the fund," Mr. Blatter said. But challenges remain, largely related to Swiss government bonds continuing to languish in negative territory, he said.

Russell Investments was also "actively rebalancing" many of its clients' portfolios in Japan to keep allocations aligned with objectives, said Konosuke Kita, Tokyo-based director of consulting at Russell Investments.

Because most Japanese pension funds are evaluated on a fiscal-year basis, "there was some pandemic impact at the end of March 2020," Mr. Kita said. At the end of March, the funding ratio of these plans was 97% on a projected benefit obligation basis.

"But because of the subsequent equity rally, these ratios have improved" to an estimated 107% — above the estimated 104% at the start of 2020, he added.

Rebalancing continues now as "the sudden equity rise" has led some pension funds to begin selling equities in order to rebalance, Mr. Kita said.

Several developments on Russell executives' radars for 2021 include the reform of the Tokyo Stock Exchange — including reducing the number of stock exchange sections to three from five, a revision of corporate governance codes, and "how to consider the U.S.-China power balance in investment decisions," Mr. Kita said.

Rounding out the seven markets is Australia, whose superannuation funds made an estimated 3.5% investment return in 2020. "Overall, we saw nine months of positive returns following the around 12% fall" between Feb. 20 and the end of March, said Kirby Rappell, Sydney-based CEO at SuperRatings Pty. Ltd.

The rebound is being driven by domestic and international equities. "I think the main challenge is everyone trying to figure out what is driving it all and how long it can persist. At the same time, those who have focused on the longer-term view are ahead this year," Mr. Rappell said.

Fixed income and cash remain "a real challenge — particularly cash," which returned 0.02% in November and 0.6% for the past year and is "unlikely to be going anywhere soon."

But the 3.5% return "is not bad at all," particularly compared with 2018's 0.6% investment gain. In 2019, super funds gained an estimated 14.7%. And since super funds usually aim for inflation plus 3% over the longer term, "we have gone from (the) mayhem of nine months ago to funds being not far off their longer-term target for the year," Mr. Rappell said.