Are corporate pensions turning into a traffic jam?

Tue Jul 5, 2011

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The road map for pensions is anything but a single Interstate cutting through the centre of the country


By Susan Barreto

When a global positioning system says to hang left, what happens when the car veers to the right instead? Any self-respecting GPS will admonish you briefly, but calculate a new map and path as well as an estimated time of arrival in a matter of seconds.

Right or left? The road map for pensions is anything but a single Interstate cutting through the centre of the country when it comes to directions drawn up by US corporations. For a number of reasons there maybe a new road map in boardrooms where the funding ratios among US corporate pension funds are on the rise and the opportunities for hedge funds to enter the picture are becoming more plentiful.

Mercer says that during the fourth quarter of 2010 many large plan sponsors publicly announced significant discretionary funding to their US pension plans. The estimated aggregate value of pension plan assets of S&P 1500 companies at 31 December was $1.37 trillion and as of 31 March that amount had grown to $1.44 trillion, while pension liabilities decreased by $20 billion over that time frame.

If hedge funds were to account for as little as 10% of US S&P 1500 companies' portfolios, there would be $144 billion to put to work. That's not to say some of them haven't made moves already.

Now that the gas tank is full, let's see what the GPS for US corporate pensions has in store. One map shows that dedicated hedge fund programmes are added as part of a broader alternative investment strategy. But if an investor were to consider a left-hand turn there is the broader question of whether or not hedge funds have a bigger role of 15%-plus to play across the investment portfolio in both hedge fund and fund of hedge fund mandates.

What does this mean in practical terms? Some believe the improved funding status of corporate pensions will lead to more direct strategy allocations. For example, some see a greater move into long/short equity as corporate pensions look to add some hedging to the biggest portion of their portfolio - US equities.

"For plan sponsors who have slashed their long-only equity mandate, an allocation to a long/short strategy, which is designed to provide downside protections and alpha generation, can be folded into a traditional equity portfolio, thereby maintaining the portfolio level allocation, including alternatives," says Carrie McCabe, founder of Lasair Capital.

McCabe, whose firm was established in 2008 with backing from a large corporate pension fund, has found that by including a long/short strategy in a portfolio, plan sponsors can look to increase annualised returns, reduce volatility and mitigate risk. According to one corporate plan sponsor, blindly allocating to equities will not happen as plans that are better funded want to de-risk the investment portfolio, which could mean an increasing reliance on fixed income as well.

Mercer has found that corporate pension assets are still largely invested in higher risk assets such as equities or real estate, with less than 40% allocated to lower risk assets such as fixed-income securities - including long-maturity fixed-income investments that can offset the changes in plan liabilities when discount rates rise or fall.

It may be that the roads that these corporations have to travel are just being built, but then again there could be roadblocks. For example, it is reported that the Department of Labor's Employee Benefits Security Administration in the US wants to expand the definition of a fiduciary and there is some concern that prime brokers' cap intro groups may be considered as fiduciaries. This would mean they would be legally responsible for offering pensions the 'right' hedge fund investments.

A quick-acting GPS might come in handy in the coming months to adjust the hedge fund itinerary, but where corporate pensions find themselves is similar to where many US public pensions were last year

in charting a realistic course to long-term investment strategies.