Many of the largest pension plans made significant changes to their asset allocation in 2014. Among the nineteen members of the $20 billion club—a group of U.S. listed corporations that each have worldwide pension liabilities in excess of $20 billion—no fewer than nine increased their allocation to fixed income by 4% or more during the year.
A couple of weeks ago, we discussed the development of the funded status of those large plans, based on data in the recently-filed 10-K reports. A new note by Justin Owens digs deeper into those reports and looks more closely at the assumptions and objectives of the plans, and at the impact these are having on contributions and investment strategies. I’ll pick up here on just a couple of the points it makes.
Little change in 2013; much change in 2014
On the surface, it may appear to be surprising that so many of these plans would make significant increases in their fixed income allocations in 2014. After all, in 2013, only one did so and, indeed, four reduced their fixed income allocations by more than 4% that year.
The change is less surprising if we take into account the importance of funded status in driving asset allocation decisions. The signs were there, as I noted a year ago: “Now that pension plans are better funded, big asset allocation moves could follow.” That this did indeed happen is further confirmation of the strong link between asset allocation and funded status for many pension plans. If the pattern holds, we ought to expect less change in 2015 (since funded status fell sharply in 2014.) But there is a wild card here, which I’ll come back to in a moment.
The herd has broken
It would be a mistake to assume that all of these plans are following the same strategy, however. Many have clearly tied their asset allocation to their funded status and at least a couple have formally described these policies. But some others have not. Not every corporation is setting the same goals for their pension plan, and not every plan is following the same strategy. The days of peer group comparisons being a major factor in decisions are long gone.
Here, again, it is easy to say this with hindsight. And, with hindsight, it is clear that the Pension Protection Act of 2006 (PPA) was an important turning point. But the signs were there at the time. In a report published¹ shortly after the passage of that Act, I said:
I believe we’ll see a breakup of the pension plan herd. Corporate pension plans have for decades tended to pursue similar objectives, adopt similar asset allocation policies, and rely on similar strategies. But change is being driven by a number of different pressures, and these pressures are going to push different plans in different directions. The impact of the Pension Protection Act of 2006 will be different for a well-funded plan than for one designated ‘at risk’, and it will be different for a corporation which is sensitive to cash flow than for one primarily concerned about earnings.
As a result, I argued, we should expect strategies to diverge—not a remarkable statement today, but one that went against decades of prior experience when it was written. The extent to which this has happened is highlighted by some of the examples Justin Owens’ note provides: discretionary contributions above the mandated minimum at Raytheon and United Technologies, but full advantage of funding relief taken by GE and some others; aggressive adoption of liability-driven investing (LDI) at Ford and GM, but a reduction in fixed income allocation at Lockheed Martin; risk transfer activity (offering lump sum payouts) at United Technologies and Boeing. A clear case of each corporation looking for the strategy that fits.
The wild card—interest rates
Any discussion of asset allocation—and especially the allocation to fixed income—at the present time would be incomplete without a mention of the level of interest rates. It has long been a widely held view of many in the pension community that interest rates are likely to rise. It can be tough to buy bonds when interest rates are seen as low, and the expectation of rising rates has probably acted as a dampener on LDI activity for a number of years now.
So the comments above about the changes to asset allocation should be taken in that context. While the distinction between tactical and strategic motivations is a level of detail beyond what is generally available in the 10-K reports, it seems fair to assume that both strategic and tactical considerations were at play. And, as we look ahead to 2015, it seems likely that both are going to be important once again.
An aside: as I went back over the 2006 report quoted above, I was amused to find that I’d gone on to say “Some strategies will stand the test of time better than others, and a new normal may emerge.” Yes: some of us really were using the phrase “new normal” in 2006. Don’t let anyone else tell you they thought of it first!