Pensions Take More Risks as Shortfalls Grow-Survey

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Pensions Take More Risks as Shortfalls Grow-Survey

By Mark McSherry, Reuters

March 22, 2004

U.S. pension plans are seeking better returns by slightly increasing their investment risk as funding shortfalls in a growing number of plans raise concerns, a report said on Monday.

Pension funds are also hiring fund managers "at an unprecedented rate" as they look for ideas to "help them keep pace with their hefty obligations," said Greenwich Associates' 2004 report on the U.S. investment management industry.

For pension funds, the stock market rebound has been largely offset by consistently low interest rates and unfavorable demographics, the report said.

When people live longer and interest rates remain low, pension funds' future obligations increase.

The report said about 16 percent of corporate pension plans were less than 75 percent funded and 45 percent were less than 95 percent funded at the beginning of last year.

Corporate pension funding ratios fell from 121 percent in 1999 to 88 percent at the end of 2002, according to the report. "The average plan was deep in the hole at the end of 2002, and the hole is getting deeper," said Dev Clifford, a Greenwich Associates consultant.

The report said institutional investors are "trying to squeeze greater returns out of traditional core debt and equity holdings, even as they increase their investments in potentially higher yielding alternative asset classes."

Exotic

Pension funds are replacing portions of their domestic bond allocations with global bonds and other higher-yielding fixed income products, the report said. It added that some plans are shifting from "core equities" to a so-called "enhanced index" strategy and "spicing up international equity portfolios with stocks from more exotic regions."

Enhanced-index managers broadly track a stock index but can take an overweight or underweight position relative to an index or employ more complicated techniques using futures and options.

The report noted that pension plans continue to increase their use of alternative investments like hedge funds and equity real estate.

The percentage of U.S. pension funds, endowments and foundations using hedge funds increased to 23 percent in 2003 from 12 percent in 2000, according to the report.

Greenwich Associates said U.S. pension fund assets invested in equity real estate rose to $192 billion in 2003 from $175 billion in 2002.

"As in the case of other asset classes, they are looking for ways to add some degree of risk and, hopefully, increase returns," said Rodger Smith, another Greenwich Associates consultant.

Greenwich Associates conducted in-person interviews with fund professionals at 563 corporate funds, 246 public funds and 215 endowments and foundations in the United States from August to October 2003.

Mark-to-Market seen as a Negative

The survey warned that any move by U.S. policy makers to make pension funds value securities in a "mark-to-market" accounting system would have "profoundly negative effects" for U.S. employees and global equity markets.

Mark-to-market allows for the revaluation of securities at current market prices.

The report said nearly 10 percent of companies said they would close their defined contribution benefit plans to new employees if mark-to-market accounting was adopted.

The survey also said pension plan executives would "execute strategies with the potential to decrease their overall equity exposures by as much as 18 per cent" if they were forced to mark to market.

"The net effect of this would be a withdrawal of tens of billions of dollars from the stock market," said Smith.

"It seems that sponsors would likely follow the example of their counterparts in Britain by closing or restricting access to their pension plans, or they intend to greatly diminish their reliance on stocks...”