Why plans that have been riding the bull market
may wish to explore more stable seating
» Risky Schemes?
The $42 billion Virginia Retirement System is undergoing
an asset allocation study to determine a new asset mix and,
according to its board chairman, an increased allocation to
fixed-income investments is on the horizon. The
Richmond-based retirement system, with a 70%/30%
equity-to-fixed-income split at present, is contemplating a
50%/50% mix of stocks and bonds, says Edwin Burton III,
chairman of the VRS board of trustees.
"We want to reduce the risk of the fund," he explained
early last month. Over the long term, Burton suggests, the
returns on equity will not be as buoyant as in past
"We have been very heavy equity players for a long time,
but, looking to the future, it is time to change."
Clearly, even the most disciplined plan sponsors have
likely found their asset-allocation strategies tested, if
not tempted, by the consistent strong overall performance
of US equities during the past several years. But, fund
officials are discovering once again that the ability to
match cash flow requirements, while achieving a stability
of return, can be just as exhilaratingparticularly in a
market that takes away as readily as it gives.
For instance, at the $120 billion New York State Common
Retirement Fund, the strategic plan for the past five years
has allocated 33% of the portfolio to bonds and 50% to
domestic equities, providing returns of 8% and 25.5%,
"Obviously, we do some rebalancing, but we have tried to
keep the pieces of the pie basically stable in regard to
the overall portfolio," notes Jeff Gordon, spokesman for
the Common Fund. "Our strategy has been to develop an asset
allocation [policy] and reexamine it every few years" for
market circumstances or fund growth that necessitates
change, says Gordon.
In the midst of change, at the end of the day, the
ability to meet benefit obligations is a key consideration
for many plan sponsors. Bond investments can offer a
consistent, predictable flow of income, as well as the
return of principal.
"The fixed-income portion of the portfolio holds a very
practical role for us. It gives the overall fund stability
and allows us to project what funds will be available for
pensions," according to Gordon.
Particularly in volatile markets, the commitment to
consistent approach also can provide great comfort. While
many plan sponsors bulked up on equity investments in the
late 1990s, DuPont Capital Management kept a self-described
"moderate" allocation to equity (60%), while making a
conscious effort to maintain its 25% commitment to bonds
(15% is directed toward venture capital investments). The
Wilmington, Delaware-based asset management firm's core
business is the $18 billion DuPont pension fund, but it has
continued to branch out, managing pension monies for
DuPont's former affiliates like Conoco as well as other
third-party pension systems.
Plan sponsors like to say that they do not react to
immediate movements in markets, but stick to their
strategic plans. There is, however, a certain tendency to
let asset allocations ride, in view of the stock market's
successful run, rather than leave the party too soon.
Still, plan sponsors should reconsider bonds, if for no
other reason than to reduce risk and volatility.
"This year, there have been about 100 days when the
market has been up by more than 2% and, with that kind of
volatility, it is a good time to take some of your chips
off the table," notes Joan Batchelder, chief fixed-income
officer for MFS Investment Management. The Boston-based
company boasts $160 billion under management, $25 billion
in fixed-income funds.
"When the stock market was doing so well, people felt
less incentive to be disciplined," Batchelder observes.
"But, when volatility is way up, as it is this year, you
have a lot of people asking 'Is overweighting in equities
appropriate?' and the answer is 'no' for an awful lot of
"Besides," says Batchelder, "this is a good time to be
looking at bonds because of macroeconomic factors. If you
are worried about inflation, either because we are late in
the economic cycle or because of oil prices going up, then
the outlook for fixed income is constructive."
During the late 1990s, when equities were red hot, the
Employee Benefit Research Institute reported that domestic
equity allocations rose from 45.3% of total portfolios in
1996 to 48.1% in 1998, with nearly all of that coming from
domestic bond allocations.
This year, Neil Wolfson, partner-in-charge at KPMG in
New York, expects bonds to outperform large-cap equities,
with expected bond returns at 3.6% and large-cap equity
returns at 3.3%. This is a big change from 1999 when
large-cap equities were up 18.3% and bonds were off
In fact, through mid-October, with the S&P 500 down
4.5% and Nasdaq down more than 17.5%, bonds were performing
quite handily: Long-term Treasurys were up 12.02%,
municipals 6.40%, and corporates 5.73%. Over the long haul,
large- and small-cap equities will again outperform bonds,
says Wolfson, but likely by a narrower margin. According to
a KPMG study, over the next five years, 90-day US Treasurys
should climb 2.4% and intermediate maturity bonds will rise
3.8%. For the same period, large-cap equities are expected
to grow by 6.6% and small-cap equities by 9.9%, a far cry
from 1996 to 1999, when large-caps rose 25.8% and small-cap
equities gained 13.8%.
Even with the big numbers produced by equity investments
over the past five years, a number of large pension systems
have maintained a relatively high level of bond
investments. The $1.3 billion City of Austin Employees
Retirement System in Texas holds about 35% of its assets in
fixed-income instruments, of which about 32% is in bonds.
While admitting big pension systems such as Austin "do
things at glacial speed," says Catherine Herrington,
pension director of the plan, it did undertake an
asset-allocation study in October and eventually rebalanced
toward fixed income.
"We looked at some alternative investment classes as
opposed to fixed income but, at that point, we decided
there wasn't any need to take additional risk. We were not
interested, for example, in moving into real estate,"
What happens when bonds have a good year, as in 2000?
The psychology is such, says Bill Brock, executive vice
president of Evaluation Associates in Norwalk, Connecticut,
"that most plan sponsors, at this point, believe they're
not making money, just recouping losses from prior years.
Even if the plans are reevaluating for the future, they are
primarily looking at their equity componentsthe growth
driver. Bonds are just a second or third priority."
Still, even Brock concedes that plan sponsors need to
use bonds on a strategic basis, "as a strategic offset to
the volatility of equities."