Plans Rocketed Up in Q403

February 10, 2004 ( - The fourth quarter of 2003 was kind to pension plans and other institutional investors with high single-digit returns.

The latest quarterly institutional survey by Mercer Investment Consulting (Mercer IC) showed the median corporate pension plan had a fourth-quarter gain of 8.6% while public plans and foundation/endowment funds had gains of 9.3% and 8.9%, respectively.

On a year-end basis, corporate plans averaged 22.3% advances, while public plans and foundation/endowment plans earned 24.3% and 23.5%, respectively. Over a 10-year period, all three plan types have averaged between 8.9% and 10% on an annualized basis.

“After several years of pension plan funding deterioration, plan funding levels rose over the course of the year, thanks to a strong equity market. However, the rise was less than anticipated, as interest rates used for liability valuation purposes declined throughout the year,” said Barry McInerney, who leads Mercer IC in the US, in a statement. “With future capital market return expectations forecasted to be lower relative to recent gains and an uncertain Federal Reserve interest rate policy, the outlook for 2004 and beyond is a cause for some concern.”

According to Mercer IC’s Pension Health Index, plan funding levels rebounded from 76% at the beginning of the year to 80% at year-end, driven by strong returns. Although funding levels improved, additional enhancements were impeded by the decline in interest rates, as the Moody’s Aa corporate bond yield declined from 6.45% in January to 6.01% at the end of December.

Based on Mercer IC’s Capital Market Outlook at year-end, a US equity portfolio is expected to return 8.3% over the next three to five years, while international equity and fixed income are expected to return 8.3% and 4.5%, respectively. For a typical plan sponsor with a mix of 50% Russell 3000, 15% MSCI EAFE and 35% Lehman Aggregate, then, the forecast plan return is 7.4%, which is well below historical norms, Mercer IC said.

Similar return expectations for US equities are forecast by investment managers, as surveyed by Mercer IC. This year, investment managers are forecasting an average 9.1% return, yet their three-year annualized return forecast is 8%, a drop of 110 basis points. Turning to fixed income, managers predict a scant 2.5% showing for 2004 but expect a three-year annualized return of 3.7%, lower than Mercer IC’s 4.5% forecast.

Returns by Investing Style

According to Mercer IC’s analysis, both value and growth managers produced positive fourth-quarter results, with the median value manager outpacing growth managers by 350 basis points. In Mercer IC’s 2003 forecast, investment managers forecast large-cap equities to return 9.3% for the year, yet this asset class exceeded expectations with a 28.7% showing. In similar fashion, the small-cap asset class returned 47.3% for the year versus a forecast of 11.2%.

The median large-cap manager underperformed the S&P 500 Index for the fourth quarter by 50 basis points and underperformed the index by 30 basis points on an annualized basis over the last 10 years Mercer found. Small-cap managers continue to best their large-cap counterparts, surpassing them by 280 basis points over the current quarter; the median small-cap manager returned 14.5% and the median large-cap manager returned 11.7%.

The international equity asset class, with a return of 17.1%, outperformed its US large-cap counterpart for the quarter by a margin of 490 basis points and outperformed US large-cap equities over the recent 12-month period by 10.5%. Currency was a positive factor to fourth quarter returns as the local index, MSCI EAFE, earned 9.3% while currency gains contributed 7.1% to the overall return of the asset class. Within the international asset class, the value style outperformed growth by 180 basis points for the quarter and by 750 basis points for the 12-monthperiod. Based on Mercer IC’s forecast international equities were expected to earn 10.4% for 2003, yet the asset class returned 39.2% on a year-to-date basis.

Within the fixed income asset class, the median core fixed income manager outperformed the index by 20 basis points in the fourth quarter and surpassed the index over a 12-month horizon by 90 basis points. Over a 10-year period, the median manager has outperformed the index by 20 basis points.  

Mercer’s 2003 forecast predicted an annual return of only 3% for the core fixed income asset class, yet the class returned 4.1% for the year and outperformed expectations by 110 basis points. Core opportunistic managers had a strong quarter relative to their benchmark as they outperformed the index by 70 basis points. The median high-yield manager had a gain of 5.6% for the quarter, but underperformed the benchmark by 20 basis points.

In assessing international fixed income performance, the median manager had returns of 7.1% and 5.3% for non-US and global mandates, respectively. Both mandates produced solid 10-year results, 7.3% and 7.6%, respectively.