According to a new analysis from UBS Securities LLC, defined-benefit pension plans are likely to post very small quarter-end rebalancing flows into either equities or bonds. This would be a break from the first quarter experience in both 2012 and 2013, when U.S. pensions were large sellers of equities and buyers of bonds. In fact, UBS expects less than $4 billion of first quarter net sales to pension funds for both equities and bonds, which is within the flow analysis model’s margin of error.
UBS explains that equities and bonds both delivered relatively low returns during first quarter 2014, mitigating asset managers’ need to strongly adjust positions one way or the other. Researchers are quick to add that the estimates only relate to mechanical rebalancing within a static asset-allocation model—i.e., the small flows don’t include bond and equity shifts that resulted from a fundamental change in strategy, such as the choice to enact a liability-driven portfolio.
Instead, the estimates track the type of “housekeeping” large pensions regularly perform to bring their portfolios closer to policy targets. Even with weak flows, UBS finds there is a growing demand for long-maturity, highly rated bonds coming from corporate pensions, which indicates more employers are looking to at least partially “de-risk” their pension portfolios.
The analysis also shows, like many others published in recent months, that surging stocks and rising bond yields over the past few years have improved both sides of the typical corporate pension’s balance sheet. Consequently, corporate sponsors increasingly are making the strategic shift to immunize their pension liabilities, UBS says.
While surging stocks trounced bonds and powered pension portfolios to stellar returns in 2013, performance has been much more muted in first quarter 2014, UBS says, in large part due to a steep selloff in the S&P 500 and most other popular equity indices. The equity selloff was exacerbated by a drop in Treasury yields in January that briefly reignited concerns regarding corporate pension solvency ratios. UBS believes this unpleasant development may have been an added catalyst in the overall corporate pension shift to de-risking.
On the equity side of the equation, higher returns and greater allocations to domestic equities have likely offset underperformance of international and emerging market stocks, UBS says. The net effect is that on a blended basis pension equity portfolios are close to flat in first quarter.
For bonds, the story was somewhat more positive, with a representative U.S. investment grade bond index returning 1.6% so far in the year. UBS says Treasury yields have stayed in a narrow range and remain below 2013 year-end levels, while corporate spreads have also tightened, further contributing to the overall positive return for the broad index.
In assessing asset flows related to fundamental shifts in large pension portfolio strategies, UBS finds there is growing demand for long-maturity, highly rated bonds from corporate pensions as part of de-risking efforts. Recent good fortunes of corporate pensions and sponsors' balance sheets flush with cash have accelerated this trend, UBS says.
According to UBS estimates, the typical large corporate plan solvency ratio climbed to just below fully funded levels at the end of 2013. This is a huge improvement from the low-70s solvency ratios observed during the Eurozone sovereign debt meltdown in 2011. The improvement came from both surging assets and falling liabilities. Furthermore, large corporate plan solvency has been achieved in no small part thanks to sponsors' record contributions, UBS says.
Researchers estimate companies have been writing checks to pension funds to the tune of $60 to $80 billion annually in the past few years. For many asset managers and chief financial officers, UBS says, these gains have been too hard-won to risk giving them away to continued market volatility. The roughly 3% dip in large corporate pension solvency in January was a rude reminder that markets can quickly take away what they give, UBS says.
A full copy of the UBS Securities LLC analysis is available here.