U.S. retirement plans last year clawed back roughly half the ground lost the year before when the start of a Federal Reserve rate hiking cycle sent high-flying stock and bond prices tumbling.
Pensions & Investments' latest annual survey of the 1,000 largest U.S. retirement plans showed their combined assets rebounding 7.1% to $13.02 trillion over the 12 months through Sept. 30, following a record plunge of 13.9% the previous year.
Assets of the largest 200 plans, meanwhile, rose 6.9% to $9.45 trillion, a little more than half the prior year's 13.4% drop.
Those outcomes would have seemed a lot to wish for when the latest survey period began on Oct. 1, 2022, amid widespread concerns about how high interest rates would need to rise to curb inflationary pressures and expectations of a looming recession.
The recession never came, thanks in part to faster-than-anticipated progress in tamping down inflation and free-spending U.S. consumers, bolstered by COVID-19 relief payments the government distributed to counter fallout from the pandemic.
Going into 2023, "we were definitely focused on a continuation" of the previous year's challenges, and a "possible recession scenario," said Jase Auby, CIO of the $181.7 billion Texas Teacher Retirement System, Austin.
In the event, "it was very gratifying to have the opposite happen," helped by a wave of new investment focused on artificial intelligence, Auby said.
The economy defied consensus calls by economists and pundits for a mild recession in 2023, agreed Michael Trotsky, executive director and CIO of the $95.2 billion Massachusetts Pension Reserves Investment Management board at a Jan. 30 investment committee meeting. Instead, inflation peaked and markets took off, with an "astounding" 26% gain for the S&P 500 — a humbling outcome for prognosticators, he added.
Bond prices, by contrast, ended little changed following a year of considerable volatility, with yields rising sharply early on in tandem with Fed rate hikes, only to retreat late in the year amid growing expectations for rate cuts in 2024. The Bloomberg U.S. Aggregate Bond index rose 0.64% over the 12 months through Sept. 30.
In other survey results, defined contribution assets for top 1,000 retirement plans — following a rare year of underperformance vis-a-vis defined benefit assets — reestablished their claim to being the fastest-growing segment of the U.S. retirement industry, jumping 12.4% to $5.32 trillion while DB assets were rising a modest 3.7% to $7.71 trillion.
At that pace, DC plan assets could surpass DB assets within five years' time.
The respective figures for the top 200 retirement plans showed defined contribution assets rising 12.1% to $3.18 trillion and defined benefit assets increasing 4.4% to $6.27 trillion — a trend accentuated by corporate sponsors' continued efforts to shrink DB pools that leave them shouldering the risks of ensuring adequate retirement outcomes for employees in favor of DC plans that shift those risks onto employees.
For the year, with few exceptions, increases in retirement assets for top 200 public defined benefit plans kept to a fairly tight range of 4.5% to 9%. The Connecticut Retirement Plans & Trust Funds' 17% gain to $50 billion in defined benefit assets made it an outlier, with roughly half of that windfall due to investment gains and the other half resulting largely from $2.5 billion in fiscal transfers approved unanimously by the state's legislature.
Year-on-year changes in retirement assets reported by corporate plans, by contrast, were all over the map, with 22 sponsors at one end of the spectrum finishing the period with a decline in assets while at the other end leading growth companies, including members of the so-called Magnificent Seven, saw surges of 20% to 30%.
That dispersion is unsurprising, given corporate sponsors' various mixes of growth assets and liability-driven investment hedges, noted Jonathan Camp, a Chicago-based managing principal with consulting firm Meketa Investment Group advising clients on LDI programs.
In the wake of last year's big rebound in equity markets, corporate clients with large exposures to growth assets would have reported relatively strong gains. But even clients with large LDI programs — liable to suffer a decline in assets in a rising rate environment — had reason to be "very, very happy with their results in 2023," as higher discount rates reduced their liabilities, leaving funded status intact, Camp said.
Many big corporate plans, meanwhile, have taken additional steps in recent years — such as pension risk transfers to insurance companies — to accelerate the drop in their DB assets, Camp noted.
P&I's latest survey results showed the estimated DB portions for a number of big corporate retirement plans declining rapidly.
For example, an estimated 10.3% drop in Ford Motor's retirement assets to $54.7 billion reflected a $7 billion decline in DB assets to $32.9 billion that more than offset a 4.2% gain in DC assets to $21.8 billion. Similarly, an estimated 3.9% drop in Lockheed Martin's retirement assets to $76.8 billion reflected a more than $7 billion drop in DB assets to $25.4 billion overwhelming an 8.7% rise in DC assets to $51.4 billion.
The story was markedly different for some of the highest-profile growth companies last year, with stellar gains for defined contribution-only retirement programs propelling them up the top 200 rankings.
Google parent Alphabet, with an estimated 25.1% jump in retirement assets to $31 billion, climbed to 78th place in the latest rankings from 95th the year before. Amazon, with an estimated 30.8% gain to $19 billion, rose to 141st place from 167th, and Apple, with an 18.6% gain to $16.1 billion, moved up to 165th place from 179th.
Some analysts see that momentum auguring a reversal of a long-term trend of corporate plans figuring less prominently in the upper reaches of P&I's retirement asset rankings.
Growth in retirement assets is affected by a number of factors beyond how well plan investments are doing, such as company and participant contributions but also, for larger growth companies, a "demographic factor" — the number of people in the plans, noted Kevin Turner, a Seattle-based managing director with Russell Investments and co-head of the firm's outsourced CIO business.
Alphabet and Amazon, by way of example, have reported gains in their employee rolls of tens of thousands and hundreds of thousands, respectively, over the past five years.
If employment gains such as those can be sustained and compounded, at some point in the future "these DC plans will rival some of the biggest DB plans by a multiple," Turner said.
In other survey results, asset mix data for the top 200 defined benefit plans showed a surprising degree of stability for a period marked by considerable policy shifts and capital market volatility over the past two years.
For example, the survey showed U.S. equities accounting for 21.9% of top 200 public defined benefit plan portfolios as of Sept. 30, up a mere 20 basis points on year despite a more than 20% gain for leading U.S. equity benchmark indexes over the period.
Mark White, executive director of the $20.7 billion, Little Rock-based Arkansas Teacher Retirement System, said those relatively stable equity figures could reflect ongoing moves by institutional investors to trim risk assets as they consider whether allocations that made sense for them in a zero-rate environment continue to do so in the higher-rate environment prevailing now.
Arkansas Teachers did really well over the past five to 10 years of zero rates — including a strong 9.2% gain for its fiscal year ended June 30 — by taking on a little more risk, reflected in its relatively large 53% allocation to public equities, White said.
But with interest rates back up now, Arkansas Teacher's board moved on Feb. 5 to take a modest amount of risk off the table, approving a 5-percentage-point drop in the fund's equity target to 48% and a corresponding boost to its fixed income exposures to 20% from 15%.
Other asset segments exhibiting stability for the past year included private equity, which claimed a 15.1% share of top 200 public plan DB portfolios, down marginally from 15.2% as of Sept. 30, 2022 — despite a plunge in equity and bond prices the year before, which might have been expected to constrain new allocations due to the denominator effect. (The denominator effect occurs when plunging equity or bond prices boost the weightings of private markets assets that can take months or years to mark to market — such as private equity, venture capital or infrastructure, potentially lifting them above an institutional investor's asset allocation ceiling.)
With stock and bond indexes both down by double digits for the survey period ended Sept. 30, 2022, for example, the weighting of private equity in top 200 defined benefit portfolios jumped to 15.2% from 12.8% the year before while real estate equity climbed to 11.8% from 8%.
But public fund CIOs described the denominator effect as more of an annoyance than an obstacle to additional allocations for the latest year.
The denominator effect didn't affect the allocations of $104 billion DB plan of the Virginia Retirement System "in any significant way," said Andrew Junkin, the Richmond-based fund's CIO.
"We ended up overweight private equity" by 2.5 percentage points but still within the fund's allowed range, in part due to the denominator effect but also due to the strong performance of the fund's private equity exposures, Junkin said.
Asset allocators said the multiyear spans private equity firms take to put commitments from institutional investors to work likewise makes the denominator effect less constraining.
"The thing to really keep in mind is the money we're allocating today isn't going to be funded for three, four or five years from now," said Texas Teacher's Auby. "So, we did have reduced capital plans in 2023 but we were still very much open for business," he said.
In any case, torrid gains for equity and bond holdings alike in the final quarter of calendar year 2023, on the back of growing hopes for Fed rate cuts, have effectively defanged any denominator effect challenges.
"It's essentially reverted now so it's probably last year's news," said Russell's Turner.
If the close of the latest survey period found many market veterans in a glass-half-full mood, conflicting views on whether a recession has been avoided or simply postponed could leave asset owners positioning their portfolios with a sense of humility in 2024.
The past year "was a year of surprise in the sense that the late cycle really lasted and is lasting more than a lot of investors would have expected" but market participants' seeming conviction now that the Fed is poised to make a series of rate cuts in 2024 could set the stage for another, less pleasant surprise, said Chris Pariseault, head of institutional portfolio managers with Boston-based Fidelity Investments.
Higher capital costs as the more than 500 basis points of rate hikes over the past two years work their way through the economy, for example, could undermine the potential for continued earnings gains that have to come through to justify the current "priced to perfection" market environment, Pariseault said.
Texas Teacher's Auby likewise sees a mild recession looming. Classic signals — like the ISM manufacturing index dipping below 50, real rates going up, leading economic indicators falling into deeply negative territory — are flashing amber or red, he noted. The coming recession should be "fairly gentle," as there are no extreme dislocations in the economy that need to be corrected, but with equity valuations so stretched "I don't think the stock market reaction will be gentle," he said.
Some market veterans say they're positioning themselves to take advantage of such opportunities, with the return of yields on both Treasuries and shorter-term notes providing options to do so without having to sacrifice portfolio returns.
Shoaib Khan, director and CIO of the New Jersey Division of Investment, said with so many moving parts at the start of 2022, his team opted to raise the $88.8 billion pension plan's cash and cash equivalents to 9% or 10%, even as an asset allocation review in 2023 slashed the portfolio's long-term target to 2% from 4%, to have the dry powder at hand to take advantage of opportunities.
"I think the verdict and the conclusions are still out (regarding) whether it's going to be a meaningful recession" or a slowdown and a soft landing, Khan said. But for now, with cash yielding about 5.4%, it's "a great place to be" while retaining the ability to take advantage of dislocations if the economy takes a turn for the worst, he said.
