Data and Research December 1, 2016

Nearly Half of Corporate Pensions Considering Lump-Sum Payouts

While a majority of plan sponsors are hedging interest rate exposure using LDI strategies, many are also turning to lump-sum distributions to reduce the absolute size of pension liability, a survey found.
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Following U.S. lawmakers’ move to increase the variable rate premiums charged by the Pension Benefit Guaranty Corporation (PBGC), nearly half of America’s pension plans are considering lump-sum payouts. 

This is according to the 2016 Defined Benefit Plan Trends Survey by investment consulting firm NEPC.

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For those plan sponsors considering other risk reduction measures, 27% said they plan to issue annuities. Twenty-five percent are considering higher contributions. Thirty-nine percent of respondents weren’t planning any changes at the time the survey was taken.

“The real game changer was what occurred at the end of last year with the PBGC rate premium decision, and plan sponsors have been scrambling on what to do ever since,” observes Brad Smith, partner in NEPC’s Corporate Practice. “Our expectation is that this anxiety about the rate premiums will continue, regardless of who is in the White House. We continue to advise clients on best approaches to improve or maintain their funded status in a low-yield environment, even with a slight rate increase expected before the end of the year.”

As projected, longevity increases are affecting pension funding. In 2016, the number of defined benefit plans with a funded status less than 80% increased to 28%, from 21% in 2015. Forty-three percent of plans have a funded status of at least 90%.

Thirty-four percent of respondents considered issuing debt to improve funded status; 47% of these plans have a funded status of less than 80%.  

The firm also points out that while a majority of plan sponsors (69%) are hedging interest rate exposure using liability driven investing (LDI) strategies, many are also taking action to reduce the absolute size of the sponsor’s pension liability by offering lump sum distributions to participants. The 38% of plans not pursuing LDI say they are waiting for interest rates to rise (34%) or are maintaining a total return approach as the plan remains open (29%).

In the past six years, plan sponsors using LDI have materially increased their LDI allocations—36% have an allocation greater than 50% or more today, versus nine percent in 2011, the survey finds.

The firm also discovered that Treasury STRIPs and other zero-coupon bonds are standing out among LDI strategies gaining popularity. Forty-five percent of funds that allocate to LDI invest in these products, versus just 10% in 2012. Long-duration government/credit bonds are the most popular LDI investment, with 62% of LDI investors using them today versus 46% in 2012.

“The only lever plan sponsors have to pull is to try and shrink the size of their liability and many still stand pat,” Smith warns. “If you look at this issue through the lens of the interest rates story, you’ll see that those plan sponsors who rejected an LDI approach as they waited for rates to rise, saw their DB plans suffer. And they’re still waiting for that entry point as equity markets continue to perform well.”

The NEPC concluded that alternative investment strategies still remain in favor, with 79% of respondents expecting to maintain their current allocation to private equity and hedge fund managers, among other opportunities. The results also show that of those plans invested in alternatives, 37% allocated between 10-25%, and eight percent allocated between 25-50% of assets.

Other key findings include: 

  • 51% of plan sponsors have a bullish outlook on the stock market for the next 12 months, while 49% are bearish. 
  • Legislative/actuarial changes to liability valuations are the greatest concern followed by low interest rate and return environment. 
  • Double-digit equity returns were not enough to stem the negative impact that lower discount rates had on pension plans. 
Investing December 1, 2016

Shifts in Asset Allocation Anticipated for Institutional Investors

Fidelity finds the top concerns for institutional investors are the low-return environment and market volatility. 

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The latest Fidelity Global Institutional Investor Survey denotes “remarkable anticipated shifts” in the use of alternative investments, domestic fixed income, and cash holding.

Globally, 72% of institutional investors say they will increase their allocation of illiquid alternatives in 2017 and 2018, with significant numbers planning to do the same with domestic fixed income (64%), cash (55%), and liquid alternatives (42%).

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Zooming in on the U.S., there appears to be some uncertainty among institutional investors with regards to equity markets. For example, compared to 2012, the percentage of U.S. institutional investors expecting to move away from domestic equity has fallen significantly from 51% to 28%, while the number of respondents who expect to increase their allocation to the same asset class has only risen from 8% to 11%.

“With 2017 just around the corner, the asset allocation outlook for global institutional investors appears to be driven largely by the local economic realities and political uncertainties in which they’re operating,” suggests Scott Couto, president, Fidelity Institutional Asset Management. “The U.S. is likely to see its first rate hike in 12 months, which helps to explain why many in the country are hitting the pause button when it comes to changing their asset allocation.”

Couto says institutions are “increasingly managing their portfolios in a more dynamic manner,” which means they are making more investment decisions today than they have in the past. In addition, the expectations of lower return and higher market volatility are driving more institutions into less commonly used assets, such as illiquid investments.

“For these reasons, organizations may find value in reexamining their investment decisionmaking process as there may be opportunities to bring more structure and accommodate the increased number of decisions, freeing up time for other areas of portfolio management and governance,” he says.

NEXT: Low return challenges

Overall, Fidelity finds the top concerns for institutional investors are the low-return environment and market volatility—even more now than in recent years. In 2010, just 25% of survey respondents cited a low-return environment as a concern and 22% cited market volatility.

“As the geopolitical and market environments evolve, institutional investors are increasingly expressing concern about how market returns and volatility will impact their portfolios,” adds Derek Young, vice chairman of Fidelity Institutional Asset Management and president of Fidelity Global Asset Allocation. “Expectations that strengthening economies would build enough momentum to support higher interest rates and diminished volatility have not borne out, particularly in emerging Asia and Europe.”

Despite their concerns, nearly all institutional investors surveyed believe that they can “still generate alpha over their benchmarks to meet their growth objectives.” The majority (56%) of survey respondents say growth, including capital and funded status growth, remain their primary investment objective, similar to 52% in 2014, according to Fidelity.

On average, institutional investors are targeting to achieve approximately a 6% required return. On top of that, they are confident in generating 2% alpha every year, with roughly half of their excess return over the next three years coming from shorter-term decisions such as individual manager outperformance and tactical asset allocation.

“Despite uncertainty in a number of markets around the world, institutional investors remain confident in their ability to generate investment returns, with a majority believing they enjoy a competitive advantage because of confidence in their staff or access to better managers,” Young explains. “More importantly, these institutional investors understand that taking on more risk, including moving away from public markets, is just one of many ways that can help them achieve their return objectives. In taking this approach, we expect many institutions will benefit in evaluating not only what investments are made, but also how the investment decisions are implemented.”

NEXT: Behaviors to address

The vast majority of survey respondents say board member emotions, board dynamics, and press coverage “have at least some impact on asset allocation decisions,” with around one-third reporting that these factors have a significant impact.

“A large number of institutional investors have to grapple with behavioral biases when helping their institutions make investment decisions,” the Fidelity study concludes. “Around the world, institutional investors report that they consider a number of qualitative factors when they make investment recommendations.”

“Whether it’s qualitative or quantitative factors, institutional investors today face an information overload,” Couto says. “To keep up with the overwhelming amount of data, institutional investors should consider revisiting and evolving their investment process.”

Top institutional investors often assess quantitative factors such as performance when making investment recommendations, while also managing external dynamics such as the board, peers and industry news as their institutions move toward their decisions.

“A more disciplined investment process may help them achieve more efficient, effective and repeatable portfolio outcomes, particularly in a low-return environment characterized by more expected asset allocation changes and a greater global interest in alternative asset classes,” Couto concludes.

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