Goldman Sachs: Many Pensions Stand in PRT Goldilocks Zone

If interest rates continue to rise, this may have a negative impact on equity valuations; consequently, according to Goldman Sachs research, the present period may represent a limited window for optimal pension risk transfer actions.

According to Goldman Sachs Asset Management’s new white paper, “Stars Aligning for Corporate Plans to Take De-Risking Actions,” almost 25% of U.S. corporate defined benefit (DB) plans are now in a fully funded or over-funded position.

As the paper’s title indicates, this means many plan sponsors are in a great position to take further de-risking actions.

“Our work would indicate that the aggregate system-wide funded level hit 91% at the end of September, the highest level since the financial crisis,” the paper says. “This represents a five percentage point improvement in funded status year-to-date and a 10 percentage point increase since the end of 2016.”

The paper says all of this is occurring when the S&P 500 has offered strong returns during the first three-quarters of 2018 and is still close to its all-time high, despite some rocky days in the second week of October.

“Consequently, many equity market valuation metrics, as well as metrics for other risk assets, are at the high end of their historical ranges,” Goldman Sachs researchers say. “If interest rates continue to rise, this may have a negative impact on equity valuations, as has been evident over the first few trading days of October. Consequently, the present period may represent a window of time when sponsors can seek to lock in gains from both higher interest rates and equity valuations. This may provide further impetus for sponsors to consider taking incremental de-risking actions within their portfolios.”

According to Goldman Sachs, a significant portion of the recent funded status improvements is also attributable to the notable contribution activity observed ahead of the September 15 tax deadline. Generally speaking, this was the deadline for pension plan sponsors to make a contribution in order to potentially benefit from a tax deduction at the higher, 2017 rate.

“It is possible that some sponsors did not immediately invest those proceeds in fixed income. For example, we suspect some sponsors may have waited to allocate some of those contributions to fixed income until their valuations were deemed to be more attractive,” the paper says. “Much of the voluntary contribution activity we have seen in 2018, whether explicitly tax reform motivated or not, was sizable, representing on average about 5% of a plan’s projected benefit obligation.”

Drawing on these findings, the paper says many DB plan sponsors will be motivated to take actions within their portfolios to secure these recently contributed funds through better asset/liability matching investment strategies.

The white paper concludes by warning plan sponsors against trying to time the markets—but by also making the important distinction that taking strategic de-risking action is not the same as market-timing.

“We have seen periods of time in the past when funded levels have risen, but plan sponsors did not move quickly enough to lock in those gains and subsequently lost that improvement when interest rates fell, credit spreads tightened or equity markets corrected,” the paper ways. “[Sponsors will remember the] dramatic drop during the financial crisis in 2008. But even other periods, such as 2011 and 2014, also saw notable declines in funded levels—although the latter was also influenced by mortality changes enacted at that time. Taking de-risking actions today is not about having to make a call on interest rates, credit spreads or equity valuations. Rather, it is about sponsors choosing to take appropriate risk management actions given the recent rise in their plans’ funded levels.”

The full white paper can be downloaded here.