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Pension’s Target Equity Allocations Shifted Down

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While stated equity targets have not declined significantly, actual equity allocations at year end were much lower. For the 83 companies that provided data, the average target equity allocation is 55 percent for 2009, compared with 58 percent for 2008. However, actual equity allocations fell over the year, to 48 percent at the end of 2008 from 59 percent the year before.

Watson Wyatt Worldwide

So although the 2008 market meltdown brought actual equity allocation in pension funds down below 50%, employers have not materially altered the target equity allocations under their pension plans’ investment policies?

If that were true, it would not be a trivial observation. Not very trivial at all. For decades, the typical pension fund held its equity allocation target steady near something like 65%, through bear and bull. Which then automatically drove an ongoing buy-low-sell-high strategy: if a bull market drove the equity allocation toward 70%, then the fund would sell stocks (at relatively high prices) to bring the equity allocation back down toward the target; conversely, if a bear market drove the equity allocation down toward 60%, then the fund would buy stocks (at relatively low prices) to bring the equity allocation back up toward the target. So if pension funds were truly holding their targets in place in the face of the meltdown, then we could expect to see some rather heavy duty cash moving into the market. Which was largely behind my bloody spring followthrough hopes, thinking that maybe just maybe I might consider heading back into the market myself as early as Memorial Day, to join the parade of all that new money coming in, instead of waiting until late 2009 or early 2010.

Except, Wyatt is wrong. And not just on the numbers, but on exactly what those numbers mean regarding the commitment of pension funds to their stocks.

“Many pension plan sponsors have remained committed to equity investments as they have been expected to provide the best long-term returns,” said Carl Hess, global head of investment consulting at Watson Wyatt.

Watson Wyatt Worldwide

Wyatt didn’t go so far as to fabricate the numbers to fit the message they’re trying to sell; but their analysis is so poor, they may as well have done so.

Instead of simply taking Wyatt’s report at face value, let’s look at companies’ disclosures in their annual statements and see what’s really going down, so to speak. By and large, pension funds’ equity investment strategies fall in one of the following classes –

  • Lower the Target to Mirror the Meltdown – By far, most of pension money appears to be planning to simply sit tight. In stark contrast to Wyatt’s characterization, the lower boundary of the ranges set for the equity allocations targets behind the lion’s share of pension funds have been lowered significantly, almost exactly mirroring the 2008 yearend equity allocation level.
    Northrup Grumman is as good an illustration as any of the numerous companies in this class. For 2007, when their pension plans’ equity allocation closed out the year at 48%, Northrup disclosed a target equity allocation range of 45%-65%. Then along came the market meltdown, sinking their pension funds’ 2008 equity allocation to 22%. But if Wyatt’s to be believed, we can count on some pretty significant stock buying from Northrup to come back up toward their target, right? Not. Northrup simply dropped their target equity allocation range to 15%-55%.
    And again, contrary to Wyatt’s implication, Northrup’s example is by far the most common case.
  • Still Within the Range – For a small minority of companies, equity investments remained within or close to being within the existing target range, even after the meltdown, so there was no immediate need to change the target. Not at all unusual for this class: having target ranges so wide, they provide no clear indication of any ongoing or future investment behavior, hence are virtually useless as an accounting disclosure.
    An illustrative member of this class: Lockheed Martin. With a very loose 2007 range of 20%-60% for U.S. equities and 10%-40% for international equities, even the 2008 meltdown didn’t send Lockheed’s equity allocation so low as to require resetting the “target,” nor will it necessitate any buy-low moves to bring the actual equity allocation back up into range.
  • Ummmm . . . GAAP Doesn’t Apply To Us – Upwards of one out of six companies (and their accountants) seem to think that the accounting standard calling for disclosure of target allocations for pension funds applies to everybody but them. Wyatt’s reference to the “83 companies that provided data” pretty much shrugs off this class without further comment.
    But given the crucial practical implications of pension funds’ investment policies – whether for the pension funds and for the finances of their sponsors, or for the market as a whole – we don’t have to leave the issue so easily. Not when the best illustration for this class is the largest elephant in the bath: GM itself. And as discussed last year exploring a major trend among some pension funds away from equity, although GM might not explicitly disclose their specific target equity allocation, they’ve told us more than enough for us to know there’s no huge flood of new stock investment coming from that neck of the woods anytime soon, if ever.

And not only are the companies outside any of these three classes extremely rare; but for any such rare birds, the investment mix rebalancing – if any at all – is going to be very very very small relative to the massive funds represented by those three classes.

So what the heck was Wyatt even looking at? They don’t disclose enough about their methodology to be certain, but I can come close to duplicating their result only by twisting two errors into my spreadsheet: (1) First, look at median results; the error there being that $1,000 reallocation going back into equity from a tiny pension fund simply ain’t the same as the $100 billion that won’t be moving around in the elephants’ pension funds. But even worse, (2) Deal with the target ranges by studying the midpoint of the ranges; the error there being two-fold, insofar as not only does it halve (or similarly chop down, depending on the changes made to the target range) the true change, but it completely ignores how obvious the real modification to the equity “commitment” has been: to drop the lower boundary of the range down to directly accommodate the meltdown without necessitating rebalancing.

The punchline: Don’t look for pension funds to come to stock buying low, thereby providing some muscle to the struggle out of the bear’s clutches. At least, not anytime soon. (With a secondary punchline: Just because an expert publishes it, don’t always believe it.)

(As I’ve previously disclaimed, posts such as this represent efforts of my favorite pastime. My formal work does not involve any of this, and none of it represents any position or comment that should in any way be attributed to my employer. Likewise, as always, it represents general personal impressions and should not be treated or used as formal professional advice.)

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Written by macheide

26 March 2009 at 4:55 pm

Posted in άctuary


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