According to Mercer IC’s Summary Performance of US Institutional Portfolios survey, the median corporate plan had a second-quarter loss of 0.1%, and public plans lost 0.2%, while foundation/endowment funds had a minimal gain of 0.1%.
That performance was down from a quarter earlier, when Mercer said that the median corporate plan had a first-quarter gain of 3.1% while both public plans and foundation/endowment funds enjoyed 3.4% advances (see Q104 No Great Shakes for Institutional Investors ).
On a one-year basis, corporate plans had average gains of 15.9%, while public plans and foundation/endowment plans earned 16.8% and 16.7%, respectively. Mercer notes that over a 10-year time frame, all three plan types have averaged between 9.8% and 10.4% on an annualized basis.
“Now that the ‘perfect storm’ of 2000-2002 has abated, plan funding ratios have begun to rise, although cash contributions by sponsors have played a major role in the rebound,” says Barry McInerney, who leads Mercer IC in the . “While the change in the capital markets environment is a welcome relief due to higher asset values and a stabilized/upward movement in interest rates – which is positive for plan liability calculations – plan sponsors are reflecting on whether their current investment strategies are still relevant today.”
In a press release McInerney went on to note, “The focus is simply not on risk as a measurement of asset volatility but on the performance of a plan’s financial metrics.”
In the report Mercer cites an evolving trend of building an asset/liability strategy by constructing a portfolio composed of three main components, each providing a unique risk/return metric:
- Liability hedging, which provides protection against changes in interest rates, which can directly impact the present value of the liabilities;
- Return enhancement, which provides modest growth potential with constrained risk parameters to match the longer-term growth in liabilities due to wage growth and inflation;
- Absolute return, which provides maximum growth potential and risk reduction due to the low correlation to other asset classes.
Mercer notes that, “By altering the allocation and amount of risk within each strategy, a sponsor will be able to calibrate their plan’s overall investment strategy in order to balance conflicting plan objectives: better matching assets to the plan’s underlying liability stream while also providing growth opportunities” – an approach that Mercer characterized as an “â€¦extension of the traditional stock/bond decision, where equities support the growth component of the liabilities while bonds act as a hedge against interest rate risk.”
According to Mercer IC’s analysis, both value and growth managers produced positive second-quarter results, with growth managers outperforming their value-oriented counterparts by 100 basis points. Based on Mercer IC’s Fearless Forecast, an annual survey of investment managers regarding their 2004 capital market expectations, large-cap equities are forecast to return 9.1% for the year, yet the asset class has only returned 3.4% for the year to date. The small-cap asset class returned 6.8% for the first half of the year compared with a forecast of 8.7%.
The international equity asset class, with a return of 0.4%, underperformed its large-cap counterpart for the quarter by a margin of 130 basis points, but outperformed US large-cap equities over the recent 12-month period by 13.8%. Currency losses hurt equity returns in the second quarter as the dollar gained strength due to a stronger economy and the prospects for higher interest rates, according to Mercer. Within the international asset class, the value style outperformed growth by 70 basis points for the quarter and by 810 basis points for the 12-month period.
Within the fixed-income asset class, the median core fixed-income manager slightly outperformed the index by 10 basis points in the second quarter and exceeded the index over a 12-month horizon by 50 basis points. Over a 10-year period, the median manager has outperformed the index by 20 basis points.
The median high-yield manager had a negative return of 0.4% for the quarter, although one-year results are strong with a return of 10.1%.