Bond Investments Gain Favor with Large Pension Funds
By Mark Johnson, Ph.D., J.D.
In the wake of stock market declines after the Great Recession of 2008, defined-benefit pension plan sponsors struggled to fund their pension obligations. Lately, a trend toward bond investments is emerging as major U.S. employers and plan sponsors seek to reduce vulnerability to market swings.
The top 100 U.S. public companies now allocate defined benefit fund assets fairly equally between bonds (39.6 percent) and stocks (40.9 percent) as of 2013, according to a recent Reuters article titled, “U.S. Corporate Pensions Bet on Bonds Even as Prices Seen Falling.” The Wall Street Journal reports that large pension funds overall hold more bonds than stocks for the first time in over a decade.
The robust stock market of 2013 helped pension funds close funding gaps created five years earlier. Pension fund managers gained confidence in 2013 that their pension funds were in a better financial position to meet future obligations. As a result, they reduced their stock market risk and protected earnings by purchasing U.S. government and corporate bonds. The move was successful, according to Mercer Investments, which reports that the average corporate pension fund moved from a 75 percent funding level at the end of 2012 to 95 percent funding in late 2013.
Kraft Food Group Inc., TRW Automotive Holdings Corp., and Clorox and are among many Fortune 500 firms that have made a major move into bonds, according to the Reuters report.
Pension funds are said to be “de-risking” by shifting assets to bonds, notes pension expert Mark Johnson. Liability-driven investing (“LDI”) is one form of investing in which the main goal is to gain sufficient assets to meet all pension liabilities, both current and future. One LDI strategy is to buy bonds and reduce equities, even when the market would seem to dictate otherwise. This asset-and-liability matching reduces a fund’s exposure to market volatility.
This uptick in bond buying has caused corporate pension funds to play a more influential role in the bond market, since pension managers tend to hold bonds for the long term. As more and more companies adopt the strategy of buying more bonds, pension demand could total $150 billion a year. It is estimated that corporate pension funds buy more than 50 percent of new long-term bonds, up from an estimated 25 percent a few years ago.
By way of background, defined-contribution plans like 401(k)s, where the employee retains responsibility for most investment decisions and funding levels, have largely replaced defined-benefit plans in the workplace. Consequently, fund managers are more focused on generating steady income to match the timing of defined benefit obligations and less concerned with the quest for high stock yields. Bonds are more attractive for this reason, since pension funds can preserve assets even if the stock market declines. Bonds are not without risk, however, since bond prices generally fall when interest rates rise.
Fortune 500 CFOs are increasingly aware of the damage underfunded pension plans can do to earnings, particularly given recent accounting changes that require greater financial reporting disclosure. Asset-and-liability matching can reduce the impact on a company’s earnings, even if the pension fund’s stock holdings drop in value.
On a related note, new actuarial projections reflect that retirees are living an average of two years longer. This fact also increases the pension fund’s obligations, and companies need to report the higher liability on their balance sheet. By investing more in bonds, companies hope to weather such volatility without too much damage to either their pension funds or their bottom line.
ABOUT THE AUTHOR: Mark Johnson, J.D., Ph.D. Mark Johnson, Ph.D., J.D., is a highly experienced ERISA expert. As a former ERISA Plan Managing Director and plan fiduciary for a Fortune 500 company, Dr. Johnson has practical knowledge of plan documents as well as an in-depth understanding of ERISA obligations. He works as an expert consultant and witness on 401(k), ESOP and pension fiduciary liability; retiree medical benefit coverage; third party administrator disputes; individual benefit claims; pension benefits in bankruptcy; long term disability benefits; and cash conversion balances.
ERISA Benefits Consulting, Inc. by Mark Johnson provides benefit consulting and advisory services and does not engage in the practice of law.
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