Brian Donohue, a partner at October Three Consulting in Chicago, says defined benefit (DB) plan funded status improved markedly in the first quarter of 2021 and, since then, plans have held on to most of this improvement. “Stocks are on track for their third consecutive double-digit return year, which has been a huge factor in pension balance sheet improvement,” he notes in October Three’s “Pension Finance Update – November 2021.”
However, the decrease in funded ratio during November nearly cancels out the prior month’s gain, according to Ned McGuire, managing director at Wilshire. The firm estimates that the aggregate funded ratio of corporate pension plans sponsored by S&P 500 companies with a duration in line with the FTSE Pension Liability Index – Short decreased by 1.1 percentage points month-over-month in November to end the month at 93.4%. The monthly change in funding resulted from a 0.9% decrease in asset values and a 0.3% increase in liability values.
According to estimates from Northern Trust Asset Management (NTAM), the average funded ratio of DB plans sponsored by S&P 500 companies declined in November from 95.2% to 93.8%. The decline was due to negative equity returns along with higher liabilities due to lower discount rates. Global equity market returns were down approximately 2.4% during the month, and the average discount rate decreased from 2.46% to 2.42% during the month, leading to higher liabilities.
“The decline occurred toward the end of the month as financial markets pulled back at the announcement of a new COVID-19 variant, Omicron,” says Jessica Hart, head of the outsourced chief investment officer (OCIO) retirement practice at NTAM. “It is premature to definitively state whether the variant’s presence will be a lasting financial market issue. We expect key information on its global health and policy impacts to come over the next few weeks.”
And it wasn’t just equities plan sponsors had to worry about. Fixed-income investments also affected funded status. Fears that effects from the latest pandemic variant could complicate economic recovery produced sizeable dips in equity markets during the month, notes River and Mercantile in its “US Pension Briefing – November 2021.” Large-cap US stocks still turned positive results, but the same wasn’t true in mid- and small-cap stocks and international markets (developed and emerging) took a bigger hit. In addition, U.S. government fixed-income securities had positive returns due to declining yields, but that wasn’t necessarily true across investment-grade or high-yield fixed income.
The end result for pension funded status is mixed and highly dependent on a plan’s asset allocation, River and Mercantile says. Most plans with diversified equity portfolios can expect slight declines in funded status for November even though discount rates remained flat. Plans that have heavy allocations to liability-matching investments will hopefully see muted funded status changes, but a lot will depend on their mix of government versus corporate fixed-income strategies, the firm says.
“While discount rates ended the month almost where they started, the change in underlying risk-free rates (i.e., Treasury yields) and the spread between those rates and corporate bond rates paint an interesting picture,” says Michael Clark, managing director in River and Mercantile’s Denver office. “The Treasury yield curve flattened during the month with longer-term maturities coming down and credit spreads widening, a sign that the market is acting cautiously with a new COVID variant starting to spread around the globe. In the short-term, rates could inch back up—even before year-end—but a lot will depend on the effects from the new COVID variant, continued GDP [gross domestic product] growth and inflation. Over the next couple of years, the economic environment is primed for rates to push higher, but just how quickly that happens and what other disruptions could occur in the meantime is anyone’s guess at this point.”
Donohue, of October Three, says, “Treasury rates moved 0.1% lower in November, producing gains of 1% or more on government bonds, while corporate bond yields were close to unchanged, producing returns of a fraction of 1% on the month. Bonds remain about 2% down for the year, with long-duration bonds performing worst.”
Both model plans October Three tracks lost ground last month. Plan A lost almost 2% in November but remains up 10% for the year, while the more conservative Plan B lost 1% last month but is still up more than 2% through the first 11 months of 2021. Plan A is a traditional plan (duration 12 at 5.5%) with a 60/40 asset allocation, while Plan B is a largely retired plan (duration 9 at 5.5%) with a 20/80 allocation and a greater emphasis on corporate and long-duration bonds.
LGIM America estimates that pension funding ratios decreased approximately 1.6% throughout November, primarily due to poor equity performance and lower Treasury yields. Its calculations indicate the discount rate’s Treasury component declined 14 basis points (bps) while the credit component widened 12 bps, resulting in a net decrease of approximately 2 bps. Overall, liabilities for the average plan increased 0.5%, while plan assets with a traditional 60/40 asset allocation declined by approximately 1.3%.
Asset manager Insight Investment estimates that pension funded status declined from 94.6% in October to 93.4% in November. Assets declined by 1.4% and liabilities declined by 0.1%.
Sweta Vaidya, North American head of solution design at Insight Investment, suggests, “In this environment of increased equity volatility and uncertainty regarding the impact of new COVID variants, plan sponsors should revisit their risk tolerance and potential implications for funded status volatility.”
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