PBGC Premium Increases Could Help Pensions De-Risk

Aon Hewitt has found that the proposal to increase PBGC premiums could incentivize plan sponsors to pre-fund, settle liabilities, and adopt de-risking strategies.

(December 16, 2013) — The new budget agreement including an increase in Pension Benefit Guaranty Corporation (PBGC) premiums is expected to help reduce funded ratio volatility and raise revenue, accord to Aon Hewitt.

The bipartisan budget act is projected to influence pensions’ risk management strategies—particularly by “creating a stronger link between contribution strategy and investment strategy.”

According to Aon Hewitt’s report, the rise in PBGC premiums will incentivize plan sponsors to settle more liabilities through lump sums and annuity purchases as well as encourage contributions above the minimum.

“In 2016 [and onwards], discretionary contributions for underfunded plans will have at least a 2.9% ‘alpha’ due to avoiding PBGC premiums,” the report said.

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And most of all, these changes would create an “asymmetric” risk/reward tradeoff for fully funded plans to help reduce funded ratio volatility—PBGC premiums can increase in “pessimistic scenarios,” but cannot decrease in “optimistic scenarios.”

“The level of PBGC variable premiums depends on how underfunded a plan gets and how long it stays underfunded,” Aon Hewitt said. “This disincentivizes high-risk/high-reward investment strategies for well funded plans.”

The consulting firm concluded that if the proposed PBGC premiums increases are enacted into law, they would encourage plan sponsors to “aggressively fund their pension plans” and pursue greater de-risking strategies such as pre-funding.

The proposal asked for a rise in carrying costs for unfunded liabilities—expected to exceed up to 3% beginning in 2016—allowing plan sponsors to explore options of pre-funding to avoid said costs.

Plan sponsors, however, may have the opportunity to add a “time dimension” to their investment strategies, Aon Hewitt said, as the legislation is phased over a few years.

(December 16, 2013) – Growth. If major asset managers’ prognosis for markets in 2014 could be summed up in a single word, this would be it.

The most frequently used term by BlackRock portfolio managers in internal blog posts was just that: “Growth.” Not even “Fed” and “tapering” combined could match it. And “Investing in Growth” was the title of JP Morgan Asset Management’s year-end report. Likewise, its counterpart out of Goldman Sachs Asset Management (GSAM) bore the headline, “Stronger Growth, More Differentiation.”

An analysis of 10 asset management firms’ outlooks for the year ahead found unanimous optimism for developed markets overall. The touch-and-go recovery of past years will likely solidify into healthy growth for 2014, the managers have broadly predicted.

“2013 was a stabilizing year, and we’re looking forward to more recovery in a moderate growth environment,” Rick Lacaille, global CIO of State Street Global Advisors (SSgA), said during a December 2 panel in New York City. “Inflation is also likely to be moderate.” Lacaille also anticipated that US monetary policy under Federal Reserve head Janet Yellen will continue with the strategy and mandate set the over the last couple of years.

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Risk assets look good, the group said, but Lacaille and a few others also suggested that hedging with little cash under the mattress could be worth the sting of 0% returns.

Two principal threats to the predicted stable global expansion came up consistently: First, a wayward exit from quantitative easing programs, and second, political upheaval in developing countries.

Due to the latter, PAAMCO decided to hold the majority of its investment book in developed markets, Director Anne-Gaelle Pouille told aiCIO. The California-based fund-of-hedge funds and advisory has $8.5 billion under management, making it a boutique relative to the traditional asset management giants.

Whereas the likes of BlackRock and SSgA have translated their bullishness into single-digit equity overweights, some smaller shops are positioning for serious offensive play in 2014.

WindhamCapital, for example, a quant-driven firm with roughly $1.5 billion in assets, has dialed up its exposure to risk assets by 30 percentage points, according to CIO Lucas Turton. Windham’s benchmark is a 50/50 split between growth and defensive assets, but reallocations from global fixed income to stocks, REITS, and commodities has taken that proportion to about 80/20.

“Systemic risk remains low,” Turton told aiCIO, thanks to “falling volatility in the equity and fixed income markets and stability of correlations between asset classes.” His group hasn’t fixated on taper day the way most other asset managers have been, but Windham’s models have deliver roughly the same forecast (although perhaps a touch sunnier).

“Our assessment indicates resilient markets,” Turton said.

While resilience in developed markets—particularly the US—was a unanimous conclusion among the 10 firms, the common stance on emerging markets was uncertainty.

“Debt in emerging economies continues to offer higher yields and the potential for both ratings upgrades and currency appreciation,” Manulife Asset Management wrote. But, the firm continued, “exposure to emerging market debt is not without risk as we witnessed with the aggressive selling of the asset class when the reduction in global monetary accommodation became more likely.”

Conviction remained low regarding developing markets, even among those managers that took a position. The overriding wisdom was to examine each country individually, and exercise caution. Europe, most agreed, was a safer bet for exposure to non-US growth assets.

Commodities and the US dollar were rare points of divisiveness. BlackRock argued that US development of the former would bolster the latter for some time to come. Goldman Sachs Asset Management agreed on the promise of the US dollar—though due to its “relative cheapness”—and labeled commodities a “neutral” asset for the year ahead. Windham was keen on commodities, however, while Investec predicted that prices will continue to “trade sideways.”

Investec’s John Stopford, the co-head of multi-asset strategies, conveyed the prevailing outlook among assets managers for 2014 in a recent video.

“We would generally favor equities over bonds for the time being,” he remarked. “Bond yields remain artificially depressed and are more likely to rise, we think, than fall over current levels—albeit at a gradual pace. But with equity markets, valuations look relatively constructive; balance sheets are in good shape; and company profits are beginning to pick up. In particular, we’re optimistic about the outlook for global growth.”