For Large Employers, Pension Costs Will Continue to Mount in 2017

Old-line companies with traditional pensions expect to spend hundreds of millions of dollars to shore up their defined benefit plans during 2017.

Xerox Corp., for instance, expects to contribute $350 million to its defined benefit plan in 2017, nearly double the amount of its contribution in 2016. DuPont says it will contribute $230 million to its main US pension plan this year, similar to the 2016 total, and hundreds of millions more to other plans.

And U.S. Steel predicts its pension expense will reach $180 million in 2017. The company put shares worth $100 million into its pension plan last year.

Large, long-established employers have been moving away from traditional pension plans toward defined contribution plans. To reduce pension risk, they’ve been closing plans to new employees, freezing benefits for existing workers and offering lump-sum buyouts to former employees.

Want the latest institutional investment industry news and insights? Sign up for CIO newsletters. 

In the meantime, returns in their pension plans have been hurt by rock-bottom interest rates and weak performance by bonds.

Xerox, for its part, says in its recent annual report that its pension plans were underfunded by nearly $2.2 billion at the end of 2016. While the Norwalk, Conn.-based company has frozen pension benefits, there’s enough uncertainty around future expenses that the pension appears among the risk factors in Xerox’s annual report.

Xerox’s pension plan allocation in 2016 included 30% stocks, 48% fixed-income instruments, 6% real estate, 8% private equity and 8% other.

U.S. Steel is in a similar situation. It froze pension benefits at the end of 2015, instead giving steelworkers 50 cents an hour as a contribution to their defined-contribution plans.

While most corporate pension plans employ conservative asset allocations, U.S. Steel says in its recent annual report that stocks and private equity account for fully 60% of its portfolio.

The Pittsburgh-based company made a well-timed move in August 2016, when it contributed 3.8 million shares of common stock valued at $100 million to its main pension plan.

The move proved prescient. U.S. Steel shares were valued at $26.57 at the time the company made the contribution to the pension plan. Since then, they’ve soared 40%.

DuPont announced in late 2016 that it would freeze pension benefits for existing employees. Meanwhile, during the fourth quarter, DuPont paid out $550 million in lump-sum payments to former employees who opted for a one-time payment over future pension benefits, the company said in its recent annual report.

Xerox, U.S. Steel and DuPont join other large, established companies in warning investors about large pension expenses. General Electric expects to contribute $1.7 billion to its pension plan in 2017. Caterpillar anticipates a contribution of $610 million this year. And Merck projects a $235 million contribution to its pension plan in 2017.

Johnson & Johnson didn’t project its pension contribution for 2017, but it contributed $838 million to pension plans in 2016. Meanwhile, Johnson & Johnson paid $420 million in lump-sum payments to former employees who agreed to them.

By Jeff Ostrowski

Commodities worldwide are in high demand based on a significant increase in assets held by unlisted natural resources funds. As of June 2016, assets in these funds reached $455 billion, while the industry grew by $48 billion in six months. All old assets under management in this fund category have tripled in size since 2008, according to a new report by Preqin.

In its new 2017 Global Natural Resources report the data, analysis and intelligence
services company found that unlisted natural resources assets grew by 12% in the first half of 2016, following two successive years in which the industry expanded by 10%.

Most of this asset growth was in “vintage” funds (funds started before 2009, according to Preqin) that hold a significant proportion of industry assets. Funds with a 2009 vintage or older hold $89 billion in total assets, almost one-fifth of the total industry.

Funds launched post-2009 have significant amounts of “dry powder” (capital yet to be invested) to invest. This may help explain why 2014 vintage funds alone account for $49 billion, almost as much as the $50 billion held by 2016-vintage vehicles. North America-focused funds account for $328 billion, or 72% of total global assets. This AUM total dwarfs those held by funds focused on Europe ($52 billion), Asia ($23 billion) or other regions ($53 billion). Similarly, energy-focused funds hold $362 billion in total assets and account for 79% of the industry AUM. Diversified natural resources funds account for 7% of AUM, while agriculture (5%), mining (4%), timberland (4%) and water (0.3%) funds are much smaller.

Want the latest institutional investment industry news and insights? Sign up for CIO newsletters. 

As a category, energy-focused funds are the fastest-growing sector of the unlisted natural resources industry. The AUM of energy funds grew by 18% in the first half of 2016, compared to 12% for agriculture funds and 6% for mining funds. Diversified natural resources funds actually saw assets decrease by 10% in the same period.

According to Tom Carr, Preqin’s Head of Real Assets Products, “the unlisted natural resources industry added almost $50 billion in combined assets in the first six months of 2016 alone. These funds are continuing to grow and the pace of growth for the industry is actually accelerating. This whole sector has seen double-digit annual increases for over a decade. At this pace, we may see the industry exceed half a trillion dollars in AUM by the end of 2017.”

Carr noted that within the asset class, the balance of assets remains heavily weighted towards energy funds and funds investing in North America. Although agriculture- and mining-focused funds have seen steady growth, they remain dwarfed by the energy sector. “Still, all primary natural resources sectors have seen consistent growth, and the asset class as a whole continues to emerge as an important part of the alternatives industry,” Carr said.

Performance Remains an Issue

The study found that 54% of respondents to Preqin’s latest survey of institutional investors said their investments in natural resources “fell short of their expectations” in 2016 as more investors were dissatisfied with their natural resources investments than were dissatisfied with their portfolios of any of the other private capital asset classes. The report said this is “a significant worry for managers” seeking to raise capital, but investors remain optimistic. The study found that investor interest in the asset class is improving, with 80% of investors considering the asset class positively or neutrally, compared with 67% at year-end 2015.

Yet despite performance concerns, investors remain bullish on the asset class entering into 2017, and 35% expect the asset class to perform better than it did in 2016, compared with 21% that believe it will perform worse.

The largest funds in the sector investing in North America are: the Riverstone Global Energy and Power Fund VI (AUM $5 billion); North America Global North Haven Infrastructure Partners II (AUM $3.6 billion); Global Stonepeak Infrastructure Partners II (AUM $3.5 billion); Water North America Carlyle Energy Mezzanine Opportunities Fund II (AUM $2.8 billion); and the Global AMP Capital Global Infrastructure Fund (AUM $2.4 billion).

Investors and Managers Neutral on Terms

As part of their survey, the study found that the majority (63%) of investors surveyed have seen no changes in prevailing fund terms over the last year, but 27% of institutions saw a change in fund terms that favor investors, compared with 9% that have witnessed changes in favor of fund managers. One reason for this change in favor of investors may be due to an increasingly competitive fundraising environment, the study suggested.

This may help explain why investors are seeing changes in management fees, how performance fees are charged, transparency and higher commitments from fund managers. Each mentioned by more than half of surveyed investors as areas in which they would like to see improvement. However, 43% of institutions reported changes to management fees and transparency in the past 12 months, indicating that fund managers have taken action to reformat their fund’s term offerings.

By Chuck Epstein