Capping a high-volatility year
January 06, 2016 — CHICAGO–(BUSINESS WIRE)–The UBS Asset Management US Pension Fund Fitness Tracker saw the funding ratio of the typical corporate US pension plan rise by approximately five percentage points to 87% in the fourth quarter of 2015.
We recalibrated our model plan to adopt the revised mortality table improvement scale issued by the Society of Actuaries in October. The revised scale has had the net effect of increasing the funding ratio by approximately two percentage points.
“In the fourth quarter, large equity returns made up for losses from the previous quarter and pushed pension plan funding ratios higher. Over 2015, market volatility increased, impacting plans’ investment portfolios. Moreover, plan liabilities saw large movements due to fluctuating discount rates (close to 100 basis points) and to changes in the mortality tables. In general, plans with a liability hedging schedule in place experienced significantly lower funding ratio volatility. Other plans chose to capitalize on volatility by tactically allocating between asset classes, leading to dispersion in funding ratios across plans,” said Frank van Etten, head of Client Solutions at UBS Asset Management.
The strong rise in Treasury yields was offset by tighter credit spreads and carry, causing liability values to remain unchanged in the fourth quarter of 2015. Investment returns of 3.2% outpaced liabilities over the quarter, causing funding ratios to increase. 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.
The fourth quarter of 2015 saw the emergence of the long-awaited bifurcation in central bank policies: While the Fed increased rates to a still supportive 0.50%, the European Central Bank and the Bank of Japan added to their balance sheets, continuing their QE policies. These moves were well-communicated and did not cause market turbulence.
Overall, the economic news was positive for industrialized countries, with the US economy continuing to chug along, and Europe and Japan on an improving trajectory. The US is still suffering from low capital expenditure, partly explained by weakness in the energy sector, which had added substantially to physical investments since the beginning of the “shale revolution.” Europe is gradually normalizing thanks to growing exports, as well as to internal demand (see for example the solid growth in car sales).
Energy demand softens
Emerging markets, as well as commodity producers, such as Australia and Canada, have however been suffering due to limited demand for energy and industrial metals. Moreover, soft worldwide demand has hindered Chinese growth. On the positive side, recent courageous reforms to the one-child policy and the residency registration regime should fuel internal demand both in the short and the long term.
During the fourth quarter, equity markets globally delivered strong positive performance. The S&P 500 Index ended the quarter up with a total return of 7.04%. The Euro Stoxx Total Return Index was up 3.73%, in US dollar (USD) terms, over the quarter. The MSCI Emerging Markets Total Return Index ended the quarter 0.73% higher in USD terms.
The yield on 10-year US Treasury notes ended the quarter up 23 basis points (bps) at 2.27%. The yield on 30-year US Treasury bonds increased 17 bps, ending at 3.02%. High-quality corporate bond credit spreads, as measured by the Barclays Long Credit A+ option-adjusted spread, ended the quarter 10 bps tighter. As a result, pension discount rates (which are based on the yield of high-quality investment grade corporate bonds) increased 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 factors had offsetting effects on liabilities 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.