Administration December 10, 2020

DB Funded Status Nearly Back to Level From Beginning of Year

A strong equity market rally in November gave defined benefit plan funded status a boost, but long-duration fixed income also performed well.

Reported by

Based on data from the top 100 defined benefit (DB) plans by liability in the S&P 500, Insight Investment estimates their current funded status to be an average 83% as of November 30.

Wilshire Associates estimates that the aggregate funded ratio for U.S. corporate pension plans sponsored by S&P 500 companies increased by 1.3 percentage points month-over-month in November to end the month at 84%. November’s funded ratio resulted from a 6.3 percentage point increase in asset values partially offset by a 4.6 percentage point increase in liability values. Over longer periods, the aggregate funded ratio is estimated to have decreased by 3.1 and 5.4 percentage points year-to-date and over the trailing 12 months, respectively, primarily due to rising liability values.

Never miss a story — sign up for PLANSPONSOR newsletters to keep up on the latest retirement plan benefits news.

“November’s funded ratio increase was primarily driven by double digit U.S. and non-U.S. public equity and real estate monthly returns, with the Wilshire 5000 Total Market Index posting multiple record highs stemming from optimism around a COVID-19 vaccine,” says Ned McGuire, managing director, Wilshire Associates. He notes that November’s funded ratio increase reverses two consecutive monthly declines in funded ratio.

River and Mercantile says an end to uncertainty surrounding the U.S. presidential election and favorable news from multiple COVID-19 vaccine developers, in addition to hope that fiscal stimulus negotiations in Congress are finally gaining momentum, are creating hope for an economic recovery in 2021. This led to extremely strong equity performance in November, both in the U.S. and internationally. Fixed income investments also had positive returns for the month.

For pension plans, the positive asset returns in November will be partially offset by liability increases, according to River and Mercantile’s Monthly Retirement Update. “Pension discount rates took one of their bigger monthly dives for the year, down 0.20% to 0.30%, bringing the total discount rate decline relative to year-end 2019 to approximately 0.70%,” the update says.

“Despite the volatility in equity markets and with interest rates, many plans many be approaching funded status levels similar to those at the beginning of the year,” says Michael Clark, managing director at River and Mercantile.

Brian Donohue, a partner at October Three Consulting, also says the stock market rally in November effectively closed a “hole” in pension finances that emerged in the first quarter, leaving plans in a position similar to where they began the year. Both model plans October Three tracks gained ground last month, with Plan A adding close to 5% and Plan B close to 2% during the month. For the year, Plan A is down less than 1% and Plan B is even. Plan A is a traditional plan (duration 12 at 5.5%) with a 60/40 asset allocation, while Plan B is a largely retired plan (duration 9 at 5.5%) with a 20/80 allocation with a greater emphasis on corporate and long-duration bonds.

According to October Three’s Pension Finance Update, for the year, a diversified stock portfolio is now up more than 14% through November, with tech (Nasdaq) overperforming massively while international markets lag. For the year, a diversified bond portfolio has gained 10% to 13%, with long duration bonds producing the best returns.

The funded status for NEPC’s hypothetical open, or total-return, plan increased 2.6%, driven by a robust performance from equities, according to its Pension Monitor report. The funded status of its frozen, or liability-driven investing (LDI)-focused plan increased 3.8%, as gains from equities and long-duration fixed income offset a relative estimated liability increase. The plan is 80% hedged, as of November 30.

The benefits of investing in long-duration fixed income were also a theme in Northern Trust Asset Management (NTAM)’s estimate of S&P 500 pension funding ratio. “Pension plans invested in long duration bonds have experienced gains to help offset the higher liabilities from the decline in rates,” says Jessica Hart, head of the outsourced chief investment officer (OCIO) retirement practice at NTAM.

NTAM estimates that the average funded ratio of corporate pension plans improved in November from 82.1% to 84.5%. Global equity market returns were up approximately 12.3% during the month. The average discount rate decreased from 2.37% to 2.08% during the month, which led to higher liabilities.

Legal & General Investment Management America (LGIMA) estimates that pension funding ratios increased approximately 2.4% throughout November, with the impact primarily due to strong equity performance outpacing plan liabilities. LGIMA’s calculations indicate the discount rate’s Treasury component decreased 5 basis points (bps), while the credit component tightened 22 basis points, resulting in a net decrease of 27 basis points. Overall, liabilities for the average plan increased approximately 4.5%, while plan assets with a traditional “60/40” asset allocation rose approximately 7.8%, according to its Pension Solutions’ Monitor.

Investing December 10, 2020

More of the Same Expected for Rates, Inflation in 2021

Interest rates were already stuck at stubbornly low levels even before the outbreak of the coronavirus pandemic, and the federal government has since signaled a commitment to accommodative monetary policy.

Reported by

During a recent webcast sponsored by Natixis Investment Managers, two fixed-income experts shared their hopes and concerns for what might be coming in 2021.

The speakers were Elaine Stokes, executive vice president and portfolio manager at Loomis, Sayles & Company; and Adam Abbas, portfolio manager and co-head of fixed income, Harris Associates. The pair noted that fixed income market watchers should now have little doubt that a “new normal” for interest rates is firmly in place. This is to say that rates were already stuck at stubbornly and historically low levels even before the outbreak of the coronavirus pandemic, and the federal government has since signaled a commitment to supporting the markets and the economy through accommodative monetary policy.

Get more!  Sign up for PLANSPONSOR newsletters.

“Central bank support is now basically the rule, wherever you look around the globe,” Stokes said. “Interest rates are low or even negative wherever you look. It’s much more than just a United States challenge.”

Stokes and Abbas said this dynamic will clearly present lasting performance challenges for investors who traditionally seek to rely on “safe assets” to drive the bulk of their portfolio returns. They suggested such conditions should give active managers a chance to shine, particularly when it comes to fixed income. At the same time, these conditions underscore the fact that government bonds and investment-grade corporate debt may now be more important as risk-ballasts in a diversified institutional portfolio, rather than return drivers, as they might have been in the past. 

When it comes to overall market volatility, Stokes and Abbas said they expect less in 2021.

“One thing that created a lot of volatility in 2020, beyond the pandemic, was political division and disagreement,” Stokes observed. “I think and hope that 2021 will bring back more conventional political tactics and strategies. This would help to bring back a longer-term view about the global economy’s potential, and that could help to give the markets more comfort. That said, depending on the outcome of the Senate runoff elections in Georgia, we will still have a divided government, and most likely at least some tensions will continue to play out.”

Stokes and Abbas said the rollout of the various coronavirus vaccines in 2021 should slowly start to reveal exactly what parts of the economy could be irrevocably changed moving forward. The pair said it remains to be seen, for example, what long-term impacts there could be on future levels of business and leisure travel. Another unknown is how commercial real estate will be impacted once the acute challenges of the pandemic have been overcome.

When it comes to the inflation outlook, Stokes and Abbas voiced very little concern. They said some areas of the U.S. and global economy could see modest inflation in 2021, but, on the other hand, other areas could face deflationary pressure. Cases in point, they noted that employee productivity has meaningfully increased this year, while serious slack has developed in the labor market. Both factors should help keep inflation in check, they said.

Consensus Views From Vanguard

The same day that Natixis presented Stokes’ and Abbas’ commentary, Vanguard published its 2021 market outlook report, “Vanguard Economic and Market Outlook 2021: Approaching the Dawn.”

At a high level, the report concludes the next phase of recovery depends on greater immunity to COVID-19 and a return to consumers engaging in normal economic activities.

“Should a vaccine become distributed, administered broadly and be effective, much of the economic losses from COVID-19 could be recovered in the next year,” Vanguard suggests. “That said, there is risk that if immunity does not rise, economies may only see marginal progress from current levels.”

According to the report, Vanguard economists expect interest rates globally to remain low, despite a constructive outlook for firming global economic growth and inflation as 2021 progresses.

“While yield curves may steepen, short-term rates are unlikely to rise in any major developed market, as monetary policy remains highly accommodative,” the report says. “Vanguard expects bond portfolios, of all types and maturities, to earn returns close to their current yield levels. As 2021 unfolds, the greatest risk factor would appear to be higher-than-expected inflation.”

The Vanguard report projects that inflation should cyclically bounce higher in the middle of 2021 from current lows, before plateauing near 2%, “but such a move could introduce market volatility.”

“In 2020, disciplined investors were yet again rewarded for remaining invested in the financial markets despite troubling headlines and a challenging environment,” the report explains. “For 2021, the wisdom will be to maintain that same level of discipline and long-term focus, while acknowledging returns may moderate from the past.”

The report concludes that economic growth and inflation will likely “stay even lower for longer” after the first phase of the economic recovery, and with the markets expecting loose monetary policy to persist.

“We find it hard to see any material uptick in fixed-income returns in the foreseeable future,” the report says. “Instead of viewing this asset class as a primary return-generating investment, investors are encouraged to view bonds from a risk-mitigating perspective. Our analysis in last year’s outlook suggested that bonds maintain their diversification benefits despite low-to-negative global yields; the events of 2020 only confirmed that.”

«