Administration October 30, 2014

Institutional Plans See Dip in Returns for Q314

October 30, 2014 (PLANSPONSOR.com) - Institutional plan sponsors lost nearly 1% in the third quarter of 2014 at the median, according to Northern Trust Universe data.
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Longer-term performance remains strong, with one-year returns for all plan types averaging 10% or greater.

Institutional plans within the Northern Trust Universe suffered a 0.8% quarterly loss due to negative returns in most investment sectors. Corporate Employee Retirement Income Security Act (ERISA) plans had the best relative performance among all plan types with a return of -0.7%. Foundations & Endowments had the second best relative performance of the quarter with a return of -0.9%. Public Funds showed a net loss of 1.3%.

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All plan types were down from the second quarter median gain of nearly 4%. Corporate ERISA plans recorded their first quarterly loss after gaining for four straight quarters. Both Public Funds and Foundations & Endowments suffered their first quarterly losses after generating positive returns for eight consecutive quarters.

Northern Trust noted that historically, the third quarter has been the worst performing quarter on record, with the average third quarter return over the last 15 years coming in at -0.1%.  It is the only quarter in the Northern Trust Universe to average a negative return. 

Despite the median loss for all plans, institutional plan sponsors have still not experienced two consecutive quarters of negative median returns since the fourth quarter of 2008 and the first quarter of 2009.

“During the third quarter, risk assets seemed to be out of favor as small-cap U.S. and international stocks, emerging market debt and high yield debt lagged,” says Bill Frieske, senior performance consultant, Northern Trust Investment Risk and Analytical Services. “Overall, market volatility, Federal Reserve tapering and weak international growth contributed to the first loss for many sponsors in several quarters.”

In the third quarter, asset allocation per segment was as follows:

  • Corporate ERISA plans were weighted towards U.S. fixed income (38.4%) and U.S. equity (28%);
  • Foundations & Endowments were weighted towards private equity (24.4%) and U.S. equity (19.4%); and
  • Public Funds were weighted towards U.S. equity (32.8%) and international equity (23.9%).

The smaller loss for corporate ERISA plans was in part due to a large allocation to U.S. fixed income, which returned 0.15% at the median. The performance of Foundations & Endowments reflected their heavier weighting towards U.S. equities, which experienced a modest decline of -0.8%. Public Funds were impacted by a 23.9% allocation to international equity markets, which performed poorly and led to a bigger loss in the quarter.

Third quarter Northern Trust Universe results showed that weak returns from the riskiest sectors of the market hurt overall plan sponsor results. Small-cap stock, both U.S. and international, lost nearly 8%. Emerging market equity and emerging market debt both lost over 3%. High yield bonds lost almost 2%.

International stock returns were negative across the board. All segments, including developed or emerging markets, large- or small-cap, all lost between 5% and 6%. 

Equity performance was largely dependent upon capitalization; returns got materially worse moving from large-cap to small-cap stocks. Large-cap managers had a median return of 0.2%, while the median return for mid-cap managers was -3.3%, and the median small-cap manager lost nearly 7%. Growth performed better than value across the range.

The Northern Trust Universe tracks the performance of about 300 large U.S. institutional investment plans, with a combined asset value of approximately $899 billion, which subscribe to performance measurement services as part of Northern Trust’s asset servicing offerings.

Administration October 30, 2014

Returns Not Keeping Pace with Multiemployer Plan Liability

October 30, 2014 (PLANSPONSOR.com) - Strong investment performance during 2013 triggered a notable improvement in the aggregate funded status of multiemployer plans over the past year, according to Milliman.
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The Milliman Multiemployer Pension Funding Study report says the overall funding shortfall for all plans declined by $45 billion for the year ending December 31, 2013, and the aggregate funded percentage increased by 9% from 72% to 81%.

The significant improvement in aggregate funded status since early 2009 reflects not only favorable investment returns, but also contribution increases (including withdrawal liability collections) and benefit reductions enacted by plans as they responded to the financial crisis. Milliman says one common misconception is that plans should be back on their feet because the stock market has surpassed its levels from before the financial crisis. However, liabilities have been growing at 7.5% per year on average, so market prices would need to be about 50% higher today to have kept pace with liability growth.

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While aggregate funding levels of multiemployer plans have nearly returned to pre-crash levels, the financial crisis has affected individual plans in different ways. The median multiemployer funded percentage of 86% as of December 31, 2013, has nearly recovered to its pre-crash level of 89%. However, the proportion of plans that are less than 80% funded has increased from 29% to 37%.

What is keeping some plans from recovering to the funding levels trustees and participants would hope for? One of the primary challenges facing traditional defined benefit (DB) plans, according to Milliman, is that they have become more mature and have less ability to recover from poor experience. Plan maturity means the number of participants who are still actively working is smaller than those who are either pensioners in pay status or vested inactive participants with a right to a deferred benefit.

From 2002 to 2012, the active population of multiemployer plans has decreased from 48% to 37% with a corresponding increase in the size of the inactive population. As a plan matures there are relatively fewer participants on whose behalf contributions are being made into pension funds, with an ever-growing level of participants entitled to current or future benefits putting a significant financial strain on these funds. In addition, Milliman explains, as a plan becomes more mature, contributions become relatively small compared with the size of the plan’s assets and liabilities, and so contribution increases are less effective at improving the plan’s funded level.

This negative cash flow—benefit payments and plan expenses increasingly outweigh contributions—magnifies the impact of investment volatility and makes it harder for plans to recover from an underfunded status, as they are forced to liquidate assets to meet obligations before asset values can recover.

The study found more mature plans are more likely to be in the yellow or red zone—plans that are less than 80% funded per the classification in the Pension Protection Act—than less mature plans. For more mature plans, the corrective tools available such as contribution increases and benefit reductions for non-retired participants are not as effective since the non-retired population is so small, so these plans have had more trouble avoiding the yellow or red zones.

According to Milliman, more than half of all plans would still need to earn 8% or more over the next 10 years to reach 100% funding. For all plans in aggregate, returns of 8.75% as of December 31, 2013, are needed over the next 10 years as compared with 10.30% as of December 31, 2012. Even if a plan recovers to 100% funding, the assumed rate of return used by these plans to calculate funding (7.5% on average) is still needed to stay fully funded.

The full study report is here.

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