Despite the low-yield environment, pension managers aren’t taking on more risk.
Like the beautiful sirens trying to lure sailors with their bewitching voices to shipwreck on the rocky shore, high risk and higher returns are out there, tempting many investment managers stuck in a low-yield environment. To be sure, some managers are chasing that risk.
But not so for many pension managers. Participants in a recent NeuGroup Defined Benefit Pension Webinar (which included members of the NeuGroup’s Treasurers’ Group of Thirty 1 and 2), said they have not been tempted to increase risk. All members polled said that their appetite for risk either remained unchanged or had been reduced in recent years.
This is despite the fact that traditional asset allocations of fixed income and equity have a projected return of between just 2 and 3 percent annually, barely beating inflation. Of course, this return profile does not close funding gaps. But no matter; risk had not increased for the members despite the fact that almost everyone faced underfunded pension obligations. One member mentioned that current gap does not concern them and expects the gap to narrow as rates rise and the investment yield on the plan increases.
According to a Fitch Ratings report, this view is inline with expectations. Fitch said that while a majority of large US corporate pension plans were underfunded at the end of 2012, it believes funding levels so far in 2013 “have improved with recent discount rate increases and strong equity market performance.”
So what are managers’ allocations? More than half of the participating members in the webinar said that pension liabilities drove their asset allocation. The rest are split between using a more traditional asset allocation and using the funding status to drive the allocation. Several members said glide path investing has become popular. One of the more creative solutions for asset allocation used by one of the members is using an efficient frontier as a roadmap for their pension investments. They work closely with an actuarial consultant to prepare the report which is updated every three years.
Although members were not tempted to increase risks, they were looking at alternatives when seeking yield. Most participants have a mix of asset classes, and a surprising number of them include private equities in their portfolio. One member mentioned that they have been using private equity for a number of years and did not see this as a “risky” alternative.
Whatever their mix, corporate pensions going forward will need to remain flexible and maintain the ability to adapt to an uncertain rate environment.