Portfolio Shifts Continue After Banner Year

Results from the “Greenwich Associates 2013 U.S. Institutional Investor Study” show the value of U.S. institutional investment portfolios increased about 11% last year, led by a combination of strong investment returns and rising interest rates that reduced the dollar amount corporations and governments must commit today to cover future pension liabilities. Despite that appreciation, institutional investors continue to implement significant changes to their portfolio management strategies and asset-allocation profiles in an effort to achieve a series of increasingly diverging objectives, says Andrew McCollum, a Greenwich Associates consultant.

McCollum explains U.S. public and corporate pension plans are reacting in very different ways to their improved funding circumstances. Corporate funds, which are subject to “mark-to-market” accounting rules that tie pension liabilities directly to the overall balance sheet and expose sponsor companies’ earnings performance to pension valuation volatility, are looking for opportunities to add risk-reducing assets.

“As companies’ funding ratios inch up, they tend to increase allocations to fixed income as part of risk-reducing asset-liability matching and liability-driven investment strategies,” McCollum says.

Other steps observed by McCollum include the closing or freezing of defined benefit (DB) plans for new and existing employees in favor of defined contribution (DB) arrangements, which define a sponsor’s commitment in dollar terms rather than benefit terms, thereby reducing long-term liability. A growing number of corporate plans are also engaging in pension buy-outs, a strategy embraced by about 10% of large U.S. corporate plan sponsors over the past three years, according to Greenwich Associates.

Some experts and observers predict 2014 will be an especially favorable time for corporations to enact buy-out strategies, in part because of increasing Pension Benefit Guaranty Corporation (PBGC) premiums. Researchers at the benefits consulting firm Mercer tell PLANSPONSOR that the increase in PBGC premiums caused the relative economic cost of running a pension plan (as compared with projected benefit liabilities) to jump about 40 basis points in recent months for a theoretical plan, up to 108.7% of liabilities as of the end of February (see “PBGC Premium Hikes Shake Up Buyout Landscape”).

The cost of retaining liabilities hovers above real liability values due to such things as administrative costs, management fees and insurance premiums. Such factors can make it more economical for a corporation to offload pension liabilities to an insurer, even with premiums running at 7% to 8% or more of total liabilities.

Public pension funds, which operate under less stringent accounting rules but have little hope of seeing large infusions of new taxpayer cash in the current economic and political environment, are taking a much different approach, McCollum says.

One common behavior among public plans is an increased allocation to alternative asset classes, with the goal of either boosting returns or reducing market correlations. Greenwich’s research finds public funds have taken action in this area by making large investments in private equity, pushing this asset class to 10% of total public pension portfolio assets—up from about 7% three years ago.

U.S. endowments and foundations continue to pursue the so-called “Yale model,” but in 2012 and 2013 they reduced allocations to alternatives for the third consecutive year. That trend appears poised for change however, as not-for-profits plan to reduce allocations to both active U.S. equities and fixed income while increasing allocations to alternatives in the coming three years.

Over the next three years, institutional investors in general say they expect to increase target allocations to alternative asset classes such as private equity, real estate, hedge funds and commodities, while reducing allocations to U.S. and regionally-focused equities.

More information is available at http://www.greenwich.com/.