Corporate Pension Risk Minimization Is Going to Become Increasingly Inefficient, Says JPM Strategist

Corporate pensions are better funded than ever, according to a new study released by JP Morgan. The data shows that the top 100 corporate pensions in the United States have finally surpassed the average funded levels achieved pre-2008. The average top-100 corporate plan today is 96.4% funded. Currently, over 70% of the plans studied were at their highest-funded levels ever since the Great Recession.

But the strategies that work for bridging a funding gap are not necessarily appropriate for better funded plans, says Jared Gross, co-author (with Michael Buchenholz) of the study and head of institutional portfolio strategy at JP Morgan.

“We’ve been in an era of gradual but persistent de-risking for the better part of the last 12 to 15 years,” says Gross. “But now that we’ve arrived at a level of funding that gives people more flexibility, it’s useful to step back and consider just how far they should go.”

Gross says that while the old models of asset allocation based on total return maximization did not work, newer models that focus heavily on liability-driven investing are also inefficient.

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“The idea that a plan should be invested almost entirely in duration matched corporate bonds and should not seek any excess return is also outdated,” says Gross. “We are arriving at a point now where risk minimization is going to become increasingly inefficient.”

Gross says that given rising wage inflation, it’s particularly useful if plan sponsors look for assets that offer some degree of inflation compensation like real estate, timber, and alternatives.

“There are many plans that still have populations of active workers, so it may be that inflation is going to be a bigger part of the liability going forward,” says Gross. “If your portfolio is entirely invested in fixed income, you are not going to keep pace with that.”

Gross also notes that 2021 was the first year since 2013 in which both asset returns and actuarial returns operated to the benefit of plan sponsors.

“That sort of situation doesn’t come around very often,” says Gross. “While that usually is a good time to take off some risk, there are other far more interesting ways to reduce risks within the return-seeking portfolio rather than pushing capital further into long duration fixed income that also preserve some degree of outperformance.”

Gross also says that there is a misconception among some plan sponsors that pension surpluses are not useful.

“There is this kind of folklore in the pension community that pension surpluses are nothing more than a trapped asset on the balance sheet that will ultimately be captured by excise taxes,” says Gross. “There’s no truth to that at all.”

Gross says that surpluses can be an important cushion against pension volatility. They can also be important for plan sponsors that want to merge plans or do a 420 transfer, a process in which excess assets are transferred to retiree health accounts.

“Just reaching 100% funding is not really the endpoint that most plans should aspire to,” says Gross.