The pension plan herd has broken up

Many investor groups are highly sensitive to peer-relative results and as a result, there can be a herd mentality in their chosen investment strategies. But large corporate pension plans in the U.S. have moved away from that mentality over the past ten years.

The $20 billion club and investment strategy

Earlier this month, I looked at the funded status of the $20 billion club (our name for the largest pension plan sponsors in the U.S.), as disclosed in their annual SEC filings. In this post, I take a closer look at the investment strategies of those plans, drawing from detailed analysis of the 10-K reports by Justin Owens.

For me, the most striking feature is the divergence between the investment approaches. Once upon a time, pension plans paid a lot of attention to peer group comparisons. At the end of this post, I append a short opinion piece that I wrote in 2006, which begins “I believe we’ll see a breakup of the pension plan herd”. It’s (almost) ten years since then—a long ten years—and much has changed. Re-reading it today, I am struck not by the fact that the breakup of the herd did indeed occur, but by the memory that when I wrote that piece, it felt like I was overstating what was really possible, stretching the truth to make my point. In the event, it was not overstated at all.

Among the twenty corporations in the $20 billion club, we today see significant differences in just about every aspect of investment strategy:

  • Return-seeking vs. liability hedging: Ford’s U.S. plans have 77% of their assets invested in fixed income, and just 7% in listed equity. Johnson & Johnson has 79% of their worldwide pension assets invested in equity, just 21% in fixed income.
  • Global or domestic bias: over half of UPS’s U.S. plan equity assets are international. Honeywell’s U.S. plan equity assets are 76% domestic.
  • Real estate: Dow, Northrop Grumman and Verizon each have around 10% of worldwide pension assets invested in real estate. Exxon Mobil has none.
  • Private equity: Verizon has a 19% allocation to private equity; Federal Express less than 1%.
  • Hedge funds: Over 12% of UPS’s pension assets are invested in hedge funds. Five club members have no allocation.

So these plans’ investment decisions are clearly being driven by factors other than a desire to track the broader peer group behavior, and that has to be a good thing.

Other herds remain intact

Although the herd mentality has been broken among large corporate pension plan sponsors, herding remains a feature in many areas of investment: among individual investors; among non-profits; among public pensions.

And even among corporate pension plans, herding behavior can be seen in other decisions that are made, frequently with good reason. For example, one notable feature of plan accounts this year has been a shift toward the use of the full yield curve for pension cost accounting. AT&T made that change in 2015, following which the large audit firms asked the SEC for their view on the acceptability of the approach. Largely as a result of the favorable response to that inquiry, at least eight other members of the $20 billion club are making the same change in 2016. So the herd is alive and well in some regards.

But when it comes to investment strategy, the pension plan herd has broken up.

Appendix: A look to the future: 2006 style

Bob Collie’s opinions from the Russell Pension Report 2007

"I believe we’ll see a breakup of the pension plan herd. Corporate pension plans have for decades tended to pursue similar objectives, adopt similar asset allocation policies, and rely on similar strategies. But change is being driven by a number of different pressures, and these pressures are going to push different plans in different directions. The impact of the Pension Protection Act of 2006 will be different for a well-funded plan than for one designated “at risk,” and it will be different for a corporation which is sensitive to cash flow than for one primarily concerned about earnings. For the latter, it will be the new accounting rules that are the dominant consideration.

The responses of corporations to today’s environment will vary depending on their industry, culture, employee attitudes, unionization and workforce mobility.

Some organizations will turn to 100% bond strategies and others to swap contracts: organizations will likely try a variety of liability-matching strategies. Other corporations will re-focus on return seeking. A few will abandon their traditional caution and instead look to endowments and foundations as their model, aggressively pursuing innovation and the leading edge. Derivative overlay accounts may become the norm for medium and large plans. (The question of whether the use of derivatives should be permitted at all is long overdue being consigned to history).

As these new paths are trodden, there will be successes and failures. One obvious point of danger is the question of plan performance reporting in a liability matching environment. Some may well slip up on that. Other pitfalls no doubt await those heading out into new territory.

In due course, the herd may well regroup; herds generally do. Some strategies will stand the test of time better than others, and a new normal may emerge. But the next few years will see pension plans moving in different directions and testing new ideas more than ever before. It’s going to be an interesting time."