Q2 Asset Gains Tempered By Rate Drops: Mercer

According to the latest quarterly survey by Mercer Investment Consulting, the median corporate plan had a second-quarter gain of 11.2%. Meanwhile, public plans and foundation/endowment funds had gains of 11.5% and 11.3%, respectively.

For the 12-month period ending June 30, corporate plans had average gains of 3.4%, underperforming public plans by 18 basis points and foundation/endowment plans by three basis points, according to the report. Over a 10-year time frame, foundation/endowment funds continue to outperform both corporate and public plans by 62 to 109 basis points, respectively. Foundation/endowment funds continued outperformance is primarily a result of a lower equity exposure (both domestic and international) and a higher percentage of alternative investments, according to Mercer.

“A strong upturn in equity asset values during the second quarter may lead many plan sponsors to anticipate an improvement in their funding status,” said Brad Blalock, head of the Midwest unit of Mercer Investment Consulting. “However, their optimism should be tempered by the fact that interest rates have continued to decline.”

Since the beginning of 2003, both corporate bond and treasury yields have declined by 70 and 60 basis points, respectively. While the median corporate plan was up 9.2%, the decline in interest rates has more than offset the rise in equity values, further eroding the funding status of most plans, Mercer analysts said.

Value over Growth

In the equity arena, both value and growth managers produced strong positive second-quarter results, with value managers bettering their growth-oriented counterparts by 300 basis points. Based on Mercer’s forecast, large-cap equities should produce a 9.3% return for the year, yet this asset class already ahead of the game with an 11.8%-return. Likewise, small-cap managers have already returned a boffo 17.9% for the year, well ahead of the forecast 11.2%.

Digging down a level within large-cap equity, both value and growth styles posted double-digit gains for the quarter – 17.3% for large-cap value and 4.3% for large-cap growth. The first quarter of the year favored growth stocks for both large-cap and small-cap equities relative to value, in line with the consensus expectations from Mercer’s investment manager survey. However, with a strong second-quarter for equities in general, value stocks outperformed growth stocks within the large-cap area, a reversal from the first-quarter, while small-cap growth stock continued to outperform their value-oriented counterparts.

The median large-cap manager trailed the S&P 500 Index for the second quarter by 40 basis points, but outperformed the index by 90 basis points on an annualized basis over the last 10 years. In a reversal of first-quarter performance, small-cap managers came in ahead of their large-cap counterparts by 630 basis points over the current quarter, as the median small-cap manager returned 21.3% and the median large-cap manager returned 15%.

Looking outside the US, the international equity asset class, with a return of 19.6%, bettered its domestic large-cap counterpart for the quarter by a margin of 420 basis points, but trailed US large-cap equities over the recent 12-month period by 6.4%. Within the international asset class, the value style outperformed growth by 100 basis points for the quarter and by only 10 basis points for the year. Based on Mercer’s forecast, international equities are expected to produce a 10.4% return for 2003, yet the asset class already has returned 9.8% during the first half of the year.

Fixed Income Betters Expectations

Within the fixed income asset class, the median core fixed income manager bested the index for the second quarter by 40 basis points and exceeded the index over the year by 60 basis points. Over a 10-year period, the median manager has outperformed the index by 20 basis points. Mercer’s forecast predicted an annual return of only 3% for the core fixed income asset class, primarily due to the historically low interest rate level, yet the asset class is already ahead of expectations with a return of 3.9%.  

Core opportunistic managers had a strong quarter as they outperformed the index by 80 basis points, as corporate securities and lower quality credits continued to rebound in anticipation of a stronger economy. The median high-yield manager had a positive gain of 7.9% for the quarter, but underperformed the benchmark by 180 basis points. In assessing international fixed income performance, a weak US dollar had a positive impact on non-US mandates, a continuation from last quarter’s trend. For the recent quarter, the median manager had returns of 5.5% and 4.7% for non-US and global mandates, respectively. Both mandates produced solid 10-year results, 7.1% and 7.2%, respectively.

The glowing second-quarter survey was miles better than a quarter before (See  Institutional Funds Rack Up Red Ink in Q1 ).