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US pensions seen favoring “bonds over stocks”: study

Posted on: March 26, 2009

Reuters – Wednesday, March 25

By John Parry

NEW YORK – After sustaining record losses in 2008, U.S. pension funds are unlikely to return to the high level of stock market allocations favored before the global financial crisis and will probably favor greater bond allocations, the author of a study said on Tuesday.

The annual Milliman Study of defined benefit pension plans, now with current total assets of some $900 billion, showed record losses of about $300 billion during the market panic of 2008. The plans included in the study represent the bulk of U.S. defined benefit pension plans, in which companies promise to pay employees specific, regular amounts once they retire.

Last year’s sell-off wiped out five years of these corporate pension plans’ gains, the study showed.

Although the allocation of assets invested in stocks is expected to rise from the low levels seen at the end of 2008, John Ehrhardt, the main author of the report, said he does not see the stocks allocations of these pension funds returning to the 60 percent level last seen at the end of 2006, before the global credit crisis struck.

“By the end of this year I think you will see equities at about 50 or 52 percent, with 35 to 38 percent in fixed income,” Ehrhardt, principal and consulting actuary in New York at Milliman, Inc., an employee benefits consulting firm, said in a telephone interview.

“Assuming a reasonable recovery going forward, I would expect equity allocations to increase to the 50 percent to 55 percent range by mid 2010,” he said.

The proportion of these plans’ assets invested in stocks had fallen to 44 percent by the end of last year from 55 percent a year earlier as stock markets plunged. Allocations to bonds rose to 41 percent from 33 percent in the same period, Milliman research showed.

At the end of 2006, bonds had represented an asset allocation of 30 percent.

“I don’t expect that we’ll ever see 60 percent equity allocations” again, Ehrhardt said.

Shaken by the damage equity markets wreaked on portfolios, in recent months, pension funds have been adding fixed income in hopes of slowly recouping some of their steep losses.

When investors fled riskier assets last year, stocks tumbled, corporate bond prices dropped and yield spreads of investment grade bonds over government Treasuries hit record highs.

Since then, pension funds have started to add corporate bonds to their holdings, aiming to collect equity-like returns near 8 percent per year with less risk than stocks.

Since the global financial crisis, “there is definitely renewed interest in some kind of liability-driven investing that in general requires a higher level of fixed income investments,” Ehrhardt said.

Long term investors such as pension funds try to project the approximate outlays they will have to make as people retire, so they need steady annual returns to help match future liabilities. In theory, stocks should generate higher returns than bonds, but only over extremely long periods.

Since 1870 the Standard & Poor’s Composite, now known as the S&P 500, has returned an annual average 8.3 percent, beating the 10-year U.S. government note’s return of about 5 percent and corporate bonds’ returns of about 6 percent, according to Bryan Taylor, chief economist with Global Financial Data in Los Angeles.

Yet market crashes such as 1929 and 2008 can rip apart the assumptions even of 20-year plus investors such as pension funds and insurers and induce them to buy more of those bonds that they consider less risky.


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