US Corporate Pension Plans Reach 91% Funded Status

(October 3, 2013) — The funded status of typical US corporate pension plans rose by 2.9 percentage points to 91% in September, owing to rising equities in US and international markets, according to BNY Mellon Investment Strategy & Solutions Group (ISSG).

This is the first time their funded status has exceeded 90% since June 2011.

BNY Mellon also reported that US public pension plans, endowments, and foundations surpassed their expected returns in September.

The rise in equities may be due to increasing investor confidence, according to Mark Bogar, managing director at the Boston Company Asset Management, an equities investment boutique.

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“We’ve seen more widespread optimism as economic conditions, especially in continental Europe and Japan, have bottomed and begun to improve,” Bogar said.

BNY Mellon found the climb in equities helped US corporate pension plans see a 3.1% increase in assets in September.

“Rising above a funded status level of 90% is important to many corporate pension plans as they are more likely to implement strategies that can lower a plan’s exposure to market volatility,” said Jeffrey Saef, managing director of BNY Mellon Investment Management and head of the ISSG. “The recent equity market returns are helping corporations outperform their liabilities.”

Liabilities were indeed lower in September, ISSG concluded. They fell 0.2%, helping the funded ratio for corporate pension plans increase 13.9 percentage points, year to date.

The data concluded that public defined benefit plans also experienced higher than expected returns last month. A typical fund reported a 3.4% excess return over its annualized 7.5% return target and was ahead of the return target by 3.8%.

ISSG also said public plans outperformed corporate plans, foundations, and endowments, particularly due to heavy allocations to private equity—an average of 10%.

The asset class performed predominantly well, gaining a 9% return in September.

(October 3, 2013) — Institutional asset owners could generate higher returns through stronger, more engaged ownership, according to research.

“Behaving Like An Owner: Plugging Investment Chain Leakages,” written by Jane Ambachtsheer and Richard Fuller of Mercer Investments and Divyesh Hindocha, who recently announced he was leaving the firm, found that incentivizing long-term investing patterns and reducing friction costs would improve returns.

These changes, the study concluded, involved significant behavioral adjustments by investors, particularly regarding their relationships with managers.

The paper, published in the Rotman International Journal of Pension Management, outlines two different types of investment “leakages”: downstream and upstream.

Downstream leakage in the financial services industry involves tangible costs from stock turnover, transition activity, and management fees. Upstream leakage is less concrete as it looks into how and why companies behave the way they do. Costs are largely beyond the investors’ control and are difficult to calculate.

According to Ambachtsheer, Fuller, and Hindocha, asset owners could reduce downstream friction costs in a variety of ways. With belief that they are holding the right stocks, investors can avoid excessive equities trading. They could also reduce manager transitions by having greater confidence and trust in the existing managers and adapting a performance standard that measures over a longer period. These behavioral changes would ensure “partner-like relationships” between asset owners and asset managers, the authors found.

Ridding upstream friction costs are similarly behavioral, the study established. Not only does it require a stronger sense of ownership by asset owners, but it also involves a more significant focus on long-term investing. Investors should resist short-terminism, especially in terms of quarterly earnings and material improvements. They should also resolve the “free-rider problem” and take on a more evolved fiduciary duty.

From the authors’ experiment of hypothetically investing $100 over a 20-year period in four different environments, it was clear that addressing both upstream and downstream costs had the most positive impact on returns.

Asset shortfalls were 25% higher than that of a 100% active investment. After 20 years, passive global equity returns was 0.75% higher than passive and active investments as well as a portfolio that addressed only downstream leakages. Active management fees were also lower than those of other scenarios.

“Asset owners are in the best position to be catalysts for the kinds of changes we propose,” the authors wrote. “Asset owners can send powerful signals for change rippling through the investment supply chain.”

Read the full paper here.