After pouring billions of dollars last year into underfunded pensions, U.S. corporations are protecting their investments by moving out of equities and into bonds.
For the first time in over a decade, more of the $1.246 trillion assets represented by the 100 largest U.S. corporate pension funds is now in bonds instead of equities, according to pension consulting firm Milliman. Assets into equities dropped to 38 percent in 2011 from 44 percent in 2010, while fixed income climbed to 41.4 percent from 36.4 percent in the same time period. The data reflect a major shift from five years ago, when assets in stocks were double those in bonds, and marked the first time the allocation to bonds exceeded stocks in the history of the Milliman survey.
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The retreat from stocks and into bonds is a trend that will continue, managers and consultants say, in response to pension deficits that are soaking up company cash and leading to a broad de-risking.
Lessons Learned
Corporations are starting to realize that the pension fund is not the place for risk, which includes the loss potential of equities.
"There will definitely be less demand for equities from corporate pensions if you look out the next several years," said Aaron Meder, head of U.S. pension solutions for Legal and General Investment Management America. Corporations are "tired of the volatility in the stock market, so they want to de-risk their pensions," he added. The volatility in equities during 2008 and 2011 is still fresh in the minds of pension plan sponsors.
Funding deficits in the Milliman survey hit a year-end record high of $326.8 billion in 2011. As a result, corporations were pressured to make $55.1 billion in cash contributions to shore up the deficits, which were surprisingly less than the $60.3 billion in 2010. Milliman expects the amount of cash contributions to rise this year. "A lot of lessons have been learned. The pension plan is not the place to be trying to drag off more return per shareholder," said Jeffrey Saef, a managing director of investment strategy at BNY Mellon who helps manage client pension plans. The aim to match high liabilities, or employee benefit obligations, with assets has become an urgent concern for many sponsors, Saef said.
So-called liability-driven investment favors long-duration credit and high-quality corporate bonds, he said. Ford Motor Co., which runs the third-largest pension fund in Milliman's survey, said last month it had reduced its stock holdings in 2011 to 32 percent of assets from 41 percent and planned to shrink further to 20 percent in coming years.
Neil Schloss, vice president and treasurer of Ford Motor, said at a JPMorgan conference that Ford will continue a liability-driven investment strategy. "We're about 45 percent bonds today and over time, we will move to a target of about 80 percent bonds."
Pressure to Leave Stocks
This year's stock market rally has not sidetracked the need to address hefty employee benefit obligations. In recent years, historically low interest rates and volatile stock markets have made it difficult for companies to get the returns they need to adequately fund their pension obligations.
"The stock market is having a really good run at the moment, but if you look at the two sides of the balance sheet ... the liabilities are outpacing the assets, and pension funds are losing ground," said Gordon Fletcher, principal at consulting firm Mercer.
The Pension Protection Act, which requires corporations to fund their pension deficits in a tight seven-year period, has also discouraged risk, said Albert Trezza, an associate director of research and analysis at BNY Mellon.
Even as markets stay at high levels, volumes are lighter than last year, while investment-grade corporate bonds, which Saef of BNY Mellon said are getting more attention from corporate pension funds, are at record sales.
Investment-grade corporate bond issuance has reached a record first-quarter high of $294.25 billion, beating the previous record of $272.3 billion in first-quarter 2007, data from Thomson Reuters unit IFR show.
"Too often we've had sponsors hooked on the drug of equities. They can't get off. And they don't have the strategy in place to get out. You've got to know when to get out of the casino," said Fletcher.
(Additional reporting by Aaron Pressman and Jennifer Ablan)