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Bonds beat stocks in pension funds, flipping 60/40

(Bloomberg) – The debate over the traditional 60/40 portfolio seems endless, but for bonds at least it’s over – and bonds have won. have raised their fixed income allocations to record levels. At the end of their final fiscal year, they held 50.2% of assets in debt while reducing the money parked in stocks to an all-time low of 31.9%. This is according to a recent report by pension advisory firm Milliman Inc. A longer-term transition, driven by federal legislation that has made fixed income more attractive, is gaining momentum even though asset class returns have gone in opposite directions and stocks have risen to record highs while a four-decade rally in US bonds is in jeopardy. Analysts see the funds’ emphasis on leverage as an acceleration and possibly the most important factor that may help cushion any increase in returns. “The large improvement in funding ratios implies a high incentive” for “private US defined benefit pension plans to become committed.” Recent gains in their funding position by accelerating risk reduction in the future, ”a team of JPMorgan Chase & Co. strategists including Nikolaos Panigirtzoglou wrote in a recent note. That means “accelerating the buying of long-term bonds and the selling of stocks”. Pension funds tend to follow a strategy of balancing liabilities – which are usually long-term – with assets of similar maturity, usually debt. While rising returns can affect returns in the short term, they are a plus as they can help lower the present value costs of obligations to challenge the wisdom of the long-held recommendation for portfolio diversification of 60% equities and 40%. Hold on to bonds. Ten-year government bond yields are up 1 percentage point since August, hitting nearly 1.8%, as an improved vaccine rollout triggers the business to reopen amid trillions of fiscal stimulus. The jump in yields resulted in the worst quarter for government bonds since 1980 and has led Wall Street to forecast even higher yields before the end of the year. In the three months leading up to March, the fourth straight quarterly increase, the S&P 500 index rose 5.8%. Until the last quarter, it was largely the best of both worlds for pension funds, with stocks outperforming long-term debt despite falling yields in recent years. This resulted in profits that exceeded the increase in pension obligations. The funded status – a measure of the extent to which annuities have enough assets to meet liabilities – of the 100 companies that Milliman tracked was 88.4%. Since 2005, the funds have also increased their allocation to “other” investments such as private equity, real estate, hedge funds and money market paper from 9.5% to 17.9%. The majority of companies have a fiscal year ending that coincides with the end of the calendar year. “The main reason for the general move from stocks to fixed income was the change in pension rules,” said Zorast Wadia, principal at Milliman. “And as the funding status of these pensions has improved, they have further reduced equity risk – investing more and more in fixed-income securities.” Under the Federal Pension Protection Act, passed in 2006, companies had a fixed amount of time to fully fund their pension plans and were required to use a certain amount market-based returns – tied to corporate bond returns – to calculate liabilities instead of their own forecasts. This change made buying debt securities more attractive than stocks in an asset-liability matching framework. The American Rescue Plan Act of 2021, the latest Covid-19 pandemic relief act, provides two forms of general funding relief for retirement plans for individual employers. It is not yet clear whether this could affect asset allocation decisions. JPMorgan predicts that state and local government-run public pension funds are also on the way to shifting more towards fixed income. These public defined benefit plans, with assets of approximately $ 4.5 trillion, have funding status that lags that of the private sector at about 60%. “So public pension funds generally have less incentive to reduce risk,” wrote Panigirtzoglou. “But you face a problem. Their equity allocation is already very high and their bond allocation is a record low of 20%. Therefore, from the point of view of the mismatch of assets and liabilities, they are under some pressure to buy bonds. “On the surface, a preference for fixed income makes little sense. Since 2005, the Bloomberg Barclays US Aggregate Bond Index has risen about 5% annually, which is about half the return on the S&P 500. Adjusted for volatility, however, equity performance was 23% worse than bonds. While optimism about the bull market for stocks seems endless, the aversion among pension funds remains. That month, Bank of America Corp. pension fund clients were Net seller of stocks, prolonging a year-long outflow trend. What corporate retirement plans “are looking for is good funding, not necessarily strong returns. “Said Adam Levine, Investment Director, Client Solutions Group, Aberdeen Standard Investment. “It is possible that as interest rates rise, corporate pensions will shift so much to fixed income securities that they counteract the rise in interest rates to a certain extent. You can certainly do this if the moves are big enough and the industry is big enough. “You can find more articles like this at Subscribe us now to stay up to date with the most trusted business news source. © 2021 Bloomberg LP

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