Discount Rate Increase Helps Grow Pensions in February

LGIMA expects heavy fixed income contributions to come.

A report from Legal and General Investment Management (LGIMA) reveals a 0.2% post-stock market selloff jump for pension funding ratios in February, driven by an increased discount rate offset by negative equity returns as well as interest and credit markets.

After experiencing the heavy correction in the beginning of February, which the LGIMA Pension Solutions Monitor mentions was initially thought to be caused by technical divers within systematic short volatility strategies, nearly every major index was in the red—a swift blow to pension plans’ funded status.

However, LGIMA saw continued positive economic data, with pension plans boasting strong Q4 earnings, a higher-than-expected CPI print, wage growth, and fiscal stimulus measures that continued to be viewed as “badly-timed.” The report also noted the growing concerns of inflation, rising rates, Federal rate increases, and both direct and indirect repercussions for risk markets.

Interest rates, on the other hand, had a positive effect on February funding ratios as the continued selloff helped move the five and 30-year Treasury rates up 13 and 19 basis points, respectively. Long-end rates also experienced an 8-basis point rise due to a strong ISM print on the first of the month. The selloff continued the following day with a surprise wage growth boost revealed in the January employment report, and although the short-lived, volatility-driven equity selloff on Feb. 5 briefly halted the bond sale, the Senate budget resolution’s passing caused it to pick up later in the week.

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After the interpretation of the Fed minutes from the January meeting, long-end rates experienced their highest intraday since July 2015 at 3.23. Later this month, Jerome Powell will take his seat as Fed Chair. According to the report, he is expected to continue the trend of optimism towards US economic growth.

According to the report, credit spreads were also good for pension funding ratios in February due to increased supply, inconsistent supply from foreign investors, and the anticipation of the approximately $40 billion CVS agreement to fund the acquisition of Aetna. Demand for long-dated credit has increased, with 30-year Treasuries above 3%, however, LGIMA saw the markets grow wider “to find a new clearing level,” LGIMA writes. LGIMA said it is seeing softer technicals from every other part of the yield curve.

As for pension liabilities, the average pension plan liabilities were down 3.1%, and for plans with a traditional 60/40 allocation, the drop was 2.9%. LGIMA also mentions that pension plan contributions have increased due to the US tax reform laws (which have raised value for cash contribution deductions), increasing PBGC premiums (which allow companies to reduce risk by funding deficit), and debt being raised by plan sponsors to fund their deficits. As plans continue to de-risk due to better funded ratios, rising interest rates, and positive equity returns, LGIMA expects a bevy of contributions to go toward fixed income.

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