Capital Markets

In Policy Shift, PBGC Turns to Stock Market

The nation's pension insurer will shrink the portion of bonds in its portfolio to 45 percent from as much as 85 percent.
David KatzFebruary 19, 2008

After five years of strictly matching its assets to its liabilities, the nation’s defined-benefit pension insurer will stock its investment portfolio with a larger percentage of equities and a new host of “alternative investments,” including real-estate and private-equity partnerships.

Under its new policy announced Tuesday, the Pension Benefit Guaranty Corporation “will allocate 45 percent of its assets to a diversified set of fixed-income investments, 45 percent to diversified equity investments and 10 percent to alternative investment classes,” according to a press release. The PBGC has about $55 billion to invest under the new investment policy.

The PBGC doesn’t select individual stocks or bonds or actively manage its portfolio. But Charles Millard, the agency’s director, says that alternative investments will include some in private-equity firms and real estate partnerships that invest in such things as office properties and warehouses. He said that the pension insurer, which employed Rocaton Investment Advisors to help it form the new policy, has no asset class in its new policy targeted to collateralized debt obligations or other securitized vehicles.

Under the agency’s previous policy, it invested between 75 percent and 85 percent in fixed-income and set an equity-investment target of 15 percent to 25 percent. The actual level of equity investments at the end of the 2007 fiscal year, however, was 28 percent.

In an interview with, PBGC Director Charles Millard disputed the notion that the agency might be moving to a more aggressive investment policy, adding that the terms “aggressive” and “conservative” don’t apply. Instead, the PBGC is moving from an “undiversified” portfolio to a much more diversified one that will mitigate risks, he added, noting that the agency is projecting that the new investment policy will have a lower standard deviation than the old.

Millard also noted that, according to a Nov. 2007 PBGC estimate, had it invested 60 percent of the portfolio in bonds and 40 percent in stock, the agency would have $7 billion more—an amount that would halve its current deficit. He also said that the new policy would supply the PBGC “with a 57
percent likelihood of full funding within ten years, compared to 19
percent under the previous policy.”

Some, however, feel that the new policy is riskier than it should be. In an E-mail sent first to the Financial Times and later to, Zvi Bodie, a Boston University finance professor and a major advocate of asset-liability matching at the PBGC, cited “the negative reactions of many of us in the community of finance professionals to this policy reversal on the part of the PBGC.”

By its action, “the PBGC is violating a fundamental principle of risk management,” Bodie wrote. “Stated simply it is this: A company that insures against hurricane damage should not invest its reserves in beachfront properties.” Since the insurer’s pension liabilities are backed by corporate pension assets and corporate share, the PBGC is exposed to the risk of a market downturn even if it doesn’t invest in a share of stock, according to the professor, who reasons that agency should invest in enough bonds and equity swaps so that its assets should be matched to its liabilities.

In its move, the PBGC is going against the current corporate tide, Millard acknowledges. Following the enactment the Pension Protection Act and Financial Accounting Standard No. 158, he says, “a lot of corporate CFOs, plan sponsors, and treasurers prefer asst-liability matching because they want to dampen balance sheet volatility.” The Pension Protection Act cut the number of years over which pensions can “smooth” their results, while the FASB rule requires corporate sponsors to put the funded status of pensions on their balance sheets.

The requirements that companies must close funding gaps in their pension plans and account for pension underfunding on their balance sheets create swings in share prices and funding decisions, according to the PBGC director. “The PBGC has no ability to increase its funding and does not have a stock price.” he says. “We do, however have a very long-term time horizon, and we are taking advantage of that.”