Pension funds are poised to shift as much as $1 trillion from stocks to bonds in coming years to lock in gains and limit the potential for big losses, according to Wells Fargo & Co.
“Definitely there’s a lot of money that will want to move,” said Andy Hunt, head of global credit and liability-driven investing at Wells Fargo Asset Management, who predicted the move will happen within roughly five years. “Best case, it’ll be between a half a trillion and a trillion.”
Struggling to make up a shortfall in funding, many pensions held on to large equity portfolios, trying to juice returns as ultra-low interest rates squeezed yields on bonds. But even a rally in the $27 trillion U.S. stock market wasn’t enough to fix the problem. Now, with corporations taking steps to narrow the gaps, managers are shifting to less volatile assets.
Fear of getting burned may even accelerate the trend, Hunt said in an interview.
The S&P 500’s record high earlier this month has raised concerns among some prominent investors that a correction may be nearing. Pacific Investment Management Co. predicts a 70% chance of a recession in the next three to five years, but said investors should start reducing risk now.
If pensions plans are caught wrong-footed -- as they were in busts earlier this century -- it can quickly spell higher costs for employers. As shortfalls widen, companies must pay steeper levies to the government’s backstop, the Pension Benefit Guaranty Corp.
“There’s a strong de-risking motivation,” Hunt said. “The question is how impactful that’s going to be for the stock market.”
So far, it’s been muted. Pension systems at dozens of the biggest U.S. publicly traded companies have been gradually boosting allocations to bonds and trimming their equity holdings in recent years, even as many stocks continued to climb. Goldman Sachs Group’s asset-management arm estimates that left plans with about 35% of their holdings in equities at the end of 2016.
That’s a lower level than the mid-1990s, when corporate and public pensions allocated more than half of their portfolios to equities, according to consulting firm Willis Towers Watson. Some of the retreat occurred after the dot-com bubble burst in 2001, then again after 2008 when “people saw that all risk assets could fall out of bed at the same time,” Hunt said.
Rising interest rates are another impetus for pensions to favor bonds, according to Zorast Wadia, principal and consulting actuary at Milliman. That’s because higher rates lift a plan’s projected funding level, freeing managers to hold less volatile, fixed-income products instead of stocks.
Companies once offered defined-benefit plans to lure and retain employees by promising them prosperity in retirement. But busts this century have left most U.S. corporate pensions in the red, with a more than $375 billion shortfall among the top 200 plans.
Many companies have been trying to fund their pensions through issuing debt or offloading liabilities to third parties, such as insurers. That means many are less inclined to hold potentially volatile stocks.
In recent decades, employers have migrated to defined-contribution plans to limit their liabilities, leaving their workers in charge of their own well-being. The mounting number of people using 401(k) plans had about two-thirds of their holdings in stocks at the end of 2014, according to the Investment Company Institute.
Such trends could help counter the impact on stock markets as pensions pull back, according to Steve Carlson, head of Willis Towers Watson’s Americas investment business.
“You’re seeing flows into defined-contribution plans,” Carlson said. “Typically that’s going to have a higher allocation to equities.”