Lockheed Reports Reduced DB Obligations from Lump Sums
While lump-sum payments to certain defined benefit plan participants reduced the company’s pension obligations, new mortality assumptions increased them.
Lump-sum
payments from Lockheed Martin’s defined benefit (DB) pension plan to certain
former employees who had not commenced receiving their vested benefit payments reduced its pension benefit obligation by a significant amount, the company reported
in a filing with the Securities and Exchange Commission (SEC).
The
company made lump-sum payments of $427 million in 2014, and the corresponding reduction
in benefit obligation was $529 million.
Lockheed
Martin announced last July that it will freeze its salaried DB plan and transition employees to an
enhanced defined contribution (DC) retirement plan.
In
the SEC filing, the company notes that the measurement of benefit obligations
is affected by key assumptions such as discount rates, employee turnover and participant
longevity, among other factors. Its benefit obligations at December 31, 2014,
reflect new longevity assumptions, which had the effect of increasing the DB
pension benefit obligations by $3.4 billion.
Lockheed
Martin utilized a discount rate of 4.00% when calculating its benefit
obligations. It noted that an increase of 25 basis points in the discount rate
assumption, with all other assumptions held constant, would have decreased its
DB benefit obligation by approximately $1.5 billion, while a decrease of 25
basis points would have increased the obligation by the same amount.
A new report from CEM Benchmarking claims to have settled, at least in part, the active versus passive investing debate for defined benefit pension plan sponsors.
Financial research and benchmarking provider CEM
Benchmarking says its most recent report contains enough data to prove active
investing is worthwhile for pension funds, if executed efficiently and effectively.
As noted in the report, “Value Added by Large Institutional
Investors Between 1992‐2013,” it is a widely held academic and investment industry
belief that active investors have, on average, no real advantage over passive
investors over the long term, and can even see worse performance over time due
to higher fees. This view on investing strategy is rooted in the efficient market hypothesis,
researchers explain.
Historically, a problem with testing the benefits of active
versus passive investing is that the separation between alpha (market
outperformance) and beta (market-attributable returns) is not always clear. “Where one set of benchmarks demonstrates a
non‐zero alpha, another set can almost always be found that shows that the
alpha is zero,” the report suggests.
But while some say the question of active versus passive cannot
be definitively answered, CEM Benchmarking believes the answer can be made
clear by looking at enough information. To that end, the firm conducted extensive analysis on its pension performance data set, composed of more than 6,600 data points drawn from
a global set of defined benefit (DB) pension plans—along with a handful of
sovereign wealth funds—spanning the 1992 to 2013 time frame
“Not only can we definitively answer the question of whether
it is possible [to outperform with active management], we can also quantify to a large degree how these institutional
investors do it,” CEM notes. “What advantages do they have? Where have they
added value? Is the value added really alpha, or is it beta in disguise?”
The results are striking: Gross of investment management
expenses, CEM says, pension funds have secured 58 basis points (bps) of value added
returns through alpha-seeking opportunities. Net of investment management fees and expenses, the outperformance is much more muted, at 16 basis points of returns added.
According to researchers, a deep regression analysis indicates that beating the
market is rooted in active asset management paired with cost savings gained
through scale and managing assets in‐house.
The result is nuanced further in the CEM report: “We
emphasize that the standard deviation of the gross and net value-added populations, at about 267 and 265 basis points, are large in comparison with the averages at 58
and 16 basis points gross and net, respectively. For any single pension fund,
this result is likely just as important as the non‐zero average. The standard
deviation indicates the range that a typical plan, with a typical active versus
passive management ratio of 4:1, can expect its value added to stray from the
average. So, while the long-term average gross and net value added are
decidedly non‐zero, in any given year many funds will trail their benchmarks,
often by substantial margins.”
Report authors continue by observing that, clearly, funds
engaging in active management need to consider whether the potential gains are
worth the risk quantified by the standard deviation.
Controlling Costs Leads to Better Alpha
Pension plans vary widely in their construction, including the amount of indexing used, the report
points out. Funds also vary according to factors such as asset scale, the amount of assets managed internally, the amount of assets
managed actively and the makeup of the asset mix.
All of these factors will impact the success of pension
funds’ active investing value add efforts, the report says.
“For example, indexing, managing assets internally, and increased
scale are all expected to reduce costs and increase net value added (all other things being equal),” the report
continues. “Attempts to beat the market by active management, by contrast, are
expected to increase grossvalue
added.”
Not surprisingly, researchers find the balance between
enhanced gross value added from security selection, on one side, and diminished
net value added from increased costs, on the other, determine whether
active management is worthwhile. What is more challenging than this realization is
actually disentangling and quantifying these differences for a given pension fund, or for pensions in general.
To this end, researchers did a regression analysis on the gross
and net value added for each pension fund in the large sample, according to a
simple model that takes into account 1) the percent of each fund’s holdings
that are internally managed; 2) the percent of each fund’s holdings that are
actively managed; 3) the size of the funds; and 4) a variable constant for each of the sample four regions.
CEM finds the following:
Pension funds increased their net value added by
+7.6 basis points for every 10-fold increase in holdings due to lower
investment management costs;
Funds increased their net value added by +22.1
basis points by managing their assets in‐house due to lower investment
management costs;
Funds increased their net value added by +38.7
basis points by actively managing their assets in an attempt to beat the market
(note this is less than the +71.7 basis points gross due to investment
management costs); and
The regression constants, themselves, are also
reduced going from gross to net value added because indexed investing, while inexpensive
relative to active management, also has associated investment management costs.
Researchers conclude that all of this goes to show that, contrary
to the efficient market hypothesis, pension funds have been able to beat the
market consistently using elements of active management. However, fees
associated with active management consistently eat up nearly 75% of the 58
basis points of gross value added, leaving only 16 basis points of net value added
for stakeholders.
“This illustrates in stark terms why funds must measure and
manage their costs,” the report concludes.
More information about obtaining or participating in CEM
Benchmarking research is here.