Driven by a rise in asset value and a drop in liabilities, corporate pension funds experienced another strong performance in July, according to analyst firms.
Wilshire estimated that U.S. corporate pension plan funding increased by two percentage points in July and ended the month at 105.4%. This comes as a result of a 0.9% rise in asset value and a 1.2% decrease in liability value.
The aggregate funded ratio is estimated to have increased by 6.7% and 10.2% year-to-date and over the trailing 12 months, respectively, according to Wilshire.
“July marked the fourth consecutive month of funded status increase, with six out of the seven months so far this year experiencing an increase,” stated Ned McGuire, managing director at Wilshire. “The FT Wilshire 5000 has seen positive returns for five consecutive months and is up nearly 20.5% year-to-date. With a liability return of approximately 2.5% and an asset return of approximately 8.7% year-to-date, the estimated July month-end funded ratio for U.S. corporate pension plans reached 105.4%. This level is the highest since year-end 2007 when it was estimated at 107.8% before the Great Financial Crisis.”
The WTW Pension Index attained its highest level since 2001. Strong investment returns, combined with a small decrease in liabilities as a result of modest increases in discount rates, contributed to raising the end-of-July index to 107.9%, an increase of 2.3 percentage points for the month.
A hypothetic pension plan invested in a 60% equity/40% fixed-income portfolio recorded a 2.1% return for the month, according to WTW. Portfolios with 20% and 60% fixed-income allocations produced 2.8% and 1.4% returns, respectively.
LGIM America’s Pension Solutions Monitor, which estimates the health of a typical U.S. corporate defined benefit pension plan, revealed similar findings, as the average funding ratio was estimated to have increased to 104.9% from 103.5%.
It also found that equity markets were strong throughout the month, with global equities increasing 3.7% and the S&P 500 increasing 3.2%. Plan discount rates were estimated to have increased five basis points over the month, with the Treasury component increasing 15 bps and the credit component tightening 10 bps.
Plan assets with a traditional 50/50 asset allocation increased 1.3% while liabilities remained relatively flat, resulting in a strong improvement in funding ratios by the end of July, according to LGIM. Overall, the increase in equities outpaced liabilities to improve funding ratios throughout the month.
The Milliman 100 Pension Funding Index also found that the funding ratio rose to 103.6% at the end of July from 102.% at the beginning of the month. Milliman credits the increase partly to a 5-bps rise in monthly discount rates, which lowered the plans’ projected obligations by $9 billion to $1.307 trillion.
July’s return of 0.84% also contributed to plans’ improved funding status, boosting the PFI assets by $5 billion, to $1.354 trillion as of July 31, according to Milliman.
“July was a win-win for pension funding,” said Zorast Wadia, author of the Milliman report. “Investment returns were better than expected, while the higher discount rates meant that liabilities declined, leading to a funded status improvement of $14 billion.”
October Three Consulting’s model plans gained ground last month, as well. A traditional plan with 60/40 asset allocation gained 3% and is now up almost 10% for the year, and a more conservative plan gained 1% during July and is now up more than 3% for the year.
According to October Three, interest rates inched higher in July, while credit spreads tightened. As a result, bonds lost 1% during July, and for the year through July, a diversified bond portfolio has earned between 2% and 3%, with long duration corporate bonds performing best.
“Pension sponsors have enjoyed a strong run so far this year, with stock markets producing double-digit returns while interest rates have held up above 5%,” October Three reported.
In addition, Aon saw the S&P 500 aggregate pension funded status increase during July to 101.7% from 100.5%. Pension assets were up throughout the month, ending with a 0.9% return, according to Aon.
Aon also reported that the month-end 10-year Treasury rate was up 16 bps relative to the June month-end rate, and credit spreads narrowed by 10 bps. This combination resulted in an increase in the interest rates used to value pension liabilities to 5.14% from 5.08%.
“Given a majority of the plans in the U.S. are still exposed to interest-rate risk, the decrease in pension liability caused by increasing interest rates compounded the positive effect of asset returns on the funded status of the plan,” Aon’s report stated.
Insight Investment’s model showed that funded status improved by 1.9%, ending July at 106.9% from 105.0% in June.
“There was a noticeable tightening in credit spreads, signaling a more positive economic outlook,” stated Sweta Vaidya, head of solution design at Insight Investment. “Fears of recession may have calmed, but all eyes are on the Fed after [the most recent] rate hike. Pension investors should review the resilience and spread diversification of their portfolios in this current environment.”
Lastly, Agilis reported that with falling liabilities and positive equity returns, plan funded statuses improved across the board. Plans with higher allocations to equities saw greater increases, while those invested in more liability-heavy assets saw smaller increases.
“July was a positive month for pension plan funded status,” stated Michael Clark, managing director at Agilis. “So far in August, discount rates have been up as spreads widened while equity markets faltered during the first week of the month. All eyes will be on the inflation report that [came] out on the 10th, and markets will be guessing [what] the Fed will do with the Fed Funds Rate as a result. We will most likely be in for a volatile August depending on how the market reacts to inflation news.”
Q2 Growth
As global equity markets posted positive gains during the second quarter of the year due to cooling inflation, pension funds also performed well over the quarter.
The Northern Trust Corporate (ERISA) universe median return was 0.8% for the quarter, trailing the Northern Trust Public Funds universe, in which the median plan was up 2.3% for the quarter.
“The Federal Reserve increased the fed funds rate by 25 bps during the quarter and commented that future [rate] increases would be on the low end of investor expectations,” stated Amy Garrigues, global head of investment risk and analytical services at Northern Trust. “This fueled optimism that inflation is receding. This, combined with continued U.S. GDP growth and global optimism in the technology sector resulting from advancements in artificial intelligence, allowed equity markets to post strong results for the quarter.”
Preliminary data from Confluence’s Plan Universe report also saw median net return of 2.82% in Q2, continuing a trend of positive performance after a slew of negative returns in 2022. The data showed that public plans and endowments and foundations posted the strongest performance, with median returns of 3.42% and 3.39%, respectively.
Looking Ahead
Under an optimistic forecast with rising interest rates (reaching 5.5% by the end of 2023 and 6.1% by the end of 2024) and asset gains (annual returns projected at 9.8%) likely to continue, Milliman predicts that the funded ratio could climb to 109% by the end of 2023 and 122% by the end of 2024.
But under a pessimistic forecast (5.0% discount rate at the end of 2023 and 4.4% by the end of 2024 and 1.8% annual returns), Milliman expects the funded ratio would decline to 100% by the end of 2023 and 91% by the end of 2024.
As discount rates have moved in a narrow range this year, and a flat yield curve is compressing rates for plans of different durations, October Three expects most pension sponsors will use effective discount rates in the 5.0% to 5.2% range to measure pension liabilities right now.
Tags: Agilis, Aon, Corporate pension funding, LGIM America’s Pension Solutions Monitor, Michael Clark, Milliman 100 Pension Funding Index, Ned McGuire, Northern Trust, October Three Consulting, Wilshire Consultants, WTW Pension Index, Zorast Wadia