Liability values up, investment returns struggle
July 07, 2016 — 7:11am (EST) –CHICAGO–(BUSINESS WIRE)–The UBS Asset Management US Pension Fund Fitness Tracker saw the funding ratio of the typical corporate US pension plan drop by approximately three percentage points to 80% in the second quarter of 2016.
“In a low rate environment, it is tempting to forgo a duration matching strategy until rates normalize. However, as yields globally grind toward historic lows, plans with a disciplined LDI program in place have been rewarded for controlling exposure,” said Frank van Etten, head of Client Solutions at UBS Asset Management.
The fall in Treasury yields during June caused liability values to increase in the second quarter of 2016. Investment returns of 2.1% could not keep up with the return on liabilities over the quarter, causing funding ratios to once again decrease. These estimates are based on the average corporate plan’s reported asset allocation weightings from the UBS Asset Management Pension 500 Database and publicly available benchmark information.
Brexit impact looms
The rather unexpected outcome of the recent referendum in the UK, where voters requested that the UK leave the European Union, has been the main headline in the financial press. Economic estimates suggest that the UK will be the country that will lose most from the voters’ decision. Some negative effects in Continental Europe are likely, while the other continents can expect minimal impact.
The US economy has continued to thread along without big surprises. A rather weak employment number in June encouraged the data-driven Fed to wait a little longer before increasing the target rate. At least one rate increase, maybe two, before the end of 2016 is possible because the labor market is tightening, the fundamentals of the economy remain solid, and inflation is converging toward the expected range around 2%.
Altogether, the world economy is not in a recession, but keeps growing below potential. Everyone’s focus is on the central banks because governments have abdicated their role in stabilizing the economy and fostering economic growth—austerity or plain inactivity seems to please voters enough to keep incumbents in charge or to replace them with populists who will serve more of the same.
During the second quarter, equity markets saw mixed returns. The S&P 500 Index ended the quarter up, with a total return of 2.46%. The Euro Stoxx Total Return Index was down 4.82%, in US dollar (USD) terms, over the quarter. The MSCI Emerging Markets Total Return Index ended the quarter only 0.80% higher in USD terms.
The yield on 10-year US Treasury notes ended the quarter down 30 basis points (bps) at 1.47%. The yield on 30-year US Treasury bonds decreased 33 bps, ending at 2.28%. High-quality corporate bond credit spreads, as measured by the Barclays Long Credit A+ option-adjusted spread, ended the quarter 4 bps tighter. As a result, pension discount rates (which are based on the yield of high-quality investment grade corporate bonds) decreased over the quarter. The passage of time caused liabilities for a typical pension plan to increase by about one percentage point over the quarter. Together, these effects caused liabilities to increase 6.1% for the quarter. (Please see disclosures for assumptions and methodology.)
Disclosures and methodology
Funding ratios measure a pension fund’s ability to meet future payout obligations to plan participants. The main factors impacting the funding ratio of a typical US defined benefit plan are equity market returns, which grow (or shrink) the asset pool from which plan participants’ benefits are paid, and liability returns, which move inversely to interest rates.
Liability indices: Methodology
Pension Protection Act (PPA) liability returns are approximated by the Barclays Capital US Long Credit A-AAA Index. This index broadly reflects the duration and credit characteristics of the PPA discount curve that is used to discount expected pension benefit payments for US defined benefit pension plans.
Asset index: Methodology
UBS Asset Management approximates the return for the ”typical” US defined benefit plan using the reported asset allocation of the UBS Asset Management Pension 500 Database. The series is constructed using the aggregate asset allocation weightings and publicly available benchmark information, with geometrically linked monthly total returns.
Pension Fund Fitness Tracker: Methodology
The US Pension Fund Fitness Tracker is the ratio of the asset index over the liability index. Assuming all other factors remain constant, it combines asset and liability returns, and measures the impact of a “typical” investment strategy on the funding ratio of a model defined benefit plan in the US due to interest rollup, change in interest rates and typical asset performance, but excludes unique plan factors, such as service cost and benefit payments. The impact of changes in mortality tables on liabilities in 2014 and 2015 was estimated to be +6% and -2%, respectively.
The UBS Asset Management Pension 500 Database
The UBS Asset Management Pension 500 Database is a proprietary database that is based on the analysis of 500 public companies sponsoring large defined benefit plans. The information was extracted from the companies’ 10-K statements, and therefore represents generally accepted accounting principles (GAAP) information. The study may include figures for companies’ nonqualified and foreign plans, both of which are not subject to ERISA. The aggregate asset allocation is based on an equally weighted average of the 500 companies included in the database. The aggregate asset allocation includes equities, fixed income, hedge funds, private equity, real estate and cash.
About UBS Asset Management
Asset Management is a large-scale asset manager with a presence in 22 countries. It offers investment capabilities and investment styles across all major traditional and alternative asset classes to institutions, wholesale intermediaries and wealth management clients around the world. It is a leading fund house in Europe, the largest mutual fund manager in Switzerland, the third-largest international asset manager in Asia, the second largest fund of hedge funds manager and one of the largest real estate investment managers in the world.
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