Pension Plan Investment Could Fuel Equity Market Crash

March 11, 2004 (PLANSPONSOR.com) - An aging workforce, less proclivity for pension plans to take large equity positions and looming global accounting changes could spell the demise of the world's equity markets.

The problem right now is that plan sponsors do not appear all that concerned. “There is a problem, it’s manageable and the time has come to start working on it,” being the statement that Mercer Investment Consulting found plan sponsors most agreed with in trying to take a barometer on the current “pension crisis.”

Some of the wave of good sentiment appears to be directly related to the recent uptick in the equity markets. However, Mercer US national practice leader Barry McInerney in the “Don’t Kill the Goose That Lays the Golden Eggs” discussion paper says despite the latest reprieve, there are still some serious problems that warrant plan sponsors’ immediate attention.

Paramount among these is the aging of the United States, and global, population base. In and of itself, this is hardly a news flash, Baby Boomers are preparing to retire and take with them their retirement savings. However, the Mercer paper says that the gradual maturation of pension plans has given these plans more bond-like characteristics regarding the nature of their liabilities. As such, plan sponsors are hesitant to take any large equity positions, expediting a trend to larger fixed income allocations.

While an all out move to total bond portfolios has not happened across the board yet, McInerney says the idea is not that far-fetched and the paradigm shift could have catastrophic consequences. Large among the potential consequences is the suppressing effect on equity valuations a total shift to bonds would have due to the amount of pension money currently locked into global equity markets.

Also tugging hard on pension plans is the potential changes to accounting standards across the world. For pension plans, this could me the elimination of “smoothing” rules that allow a pension to amortize gains and losses of the plan over a number of years. McInerney sees serious consideration being given to the adoption of more marked-to-market measures that would recognize the market value of assets and the immediate recognition of gains and losses, replacing the current smoothing mechanisms.

So what is the potential for such an accounting move? Simply put, it takes the focus off of the long term and has participants and corporate investors examining the potential immediate impact should every pension liability come due tomorrow. With this short-term scrutiny now affixed on the plan, investment managers may be less prone to take large equity positions and fuel the fire for larger bond exposures, opening up the aforementioned Pandora’s box of over fixed-income investing.

To prevent the tsunami, Mercer says the plan sponsor community needs to “engage in open discussion and debate with all of the relevant stakeholders – and lobby for change if appropriate.” Specifically, McInerney offers four areas the industry needs to address:

  • the impact of marked-to-market accounting standards
  • full understanding of the theory of financial economics as it applies to pension plans
  • lobbying of governments to ensure a complete yield curve is available to institutional investors
  • better understand the possible ramifications of a significant shift out of equities by pension plans.

«