Risk Management

Pension Funds Taking More Risk

The recent run-up in stock prices has been largely offset by low interest rates.
Stephen TaubMarch 29, 2004

U.S. pension funds are taking on a little more risk in an effort to keep pace with their growing pension obligations. In addition, they are interviewing and hiring new investment managers at an unprecedented rate as they search for innovative strategies, according to a pair of new studies recently published by consultancy Greenwich Associates.

The recent run-up in stock prices has been largely offset by low interest rates that increased future pension obligations, pointed out the consultancy, leaving plan sponsors faced with the continuing challenge of addressing funding gaps that widened during the post-bubble market collapse.

At the beginning of last year, about 16 percent of corporate pension plans were less than 75 percent funded and 45 percent were less than 95 percent funded, according to Reuters. Corporate pension funding ratios fell from 121 percent in 1999 to 88 percent at the end of 2002, added the wire service.

As a result, institutional investors are trying to squeeze greater returns out of traditional core debt and equity holdings, even as they increase their investments in potentially higher-yielding alternative asset classes. For example, funds are replacing core equities with enhanced index strategies in many portfolios. They are also replacing some basic equities in their international portfolios with slightly riskier stocks in emerging markets offering the possibility of considerably higher rewards, noted Greenwich.

In the bond portfolio, plan sponsors are adding assignments with global bonds, high-yield bonds, and even, to a lesser extent, private placements.

They are also aggressively moving deeper into hedge funds. According to Greenwich, 23 percent of pension funds use hedge funds today, compared with 12 percent in 2000.”

And U.S. pension fund assets invested in equity real estate jumped from $175 billion in 2002 to $192 billion in 2003 — roughly 50 percent higher than investment levels of the late 1990s. “There are more plan sponsors investing in equity real estate today, and those that do invest are putting more money into the asset class,” said Smith. “As in the case of other asset classes, they are looking for ways to add some degree of risk and, hopefully, increase returns.”

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