Pension plan sponsors are integrating the successful investment strategies employed by endowments and foundations, including strategies for closely matching plan assets to pension liabilities, according to a recent report by Greenwich Associates.
The 2008 Greenwich Associates U.S. Asset Allocation Report reveals that pension plan sponsors are making significant changes to their portfolios.
“What we’re seeing is a fundamental shift in how institutions manage their assets,” says Greenwich Associates consultant Dev Clifford. “Although the new approach is still a work in progress, institutions seem to believe that new financial instruments and strategies will allow them to optimize investment performance while also ensuring their ability to fund future liabilities.”
The report explains that plan sponsors are expanding their holdings of alternative investments, especially hedge funds and private equity. U.S. plan sponsors are also diversifying their portfolios by increasing their exposure to international investments, particularly foreign equities, which plan sponsors expect to outperform domestic stocks by a wide margin. As well, they are exploring ways to minimize their funds’ exposure to interest rate risk and related portfolio volatility risk by adopting techniques such as asset-liability matching and liability-driven investment strategies.
According to the report, since 2005 roughly 38% of the funds polled said they were expecting to make a significant change to their asset mixes within the next three years. Greenwich has identified several events over the past year which seem to indicate that such changes are presently underway.
Assets allocated to international stocks have increased to 17.9% of total assets in 2007 from 15.2% the prior year, and allocations to domestic equities continued to drop, falling to 41.7% in 2007 from 44.8% in 2006. Many funds cut domestic fixed-income allocations to 21.4% from 22.4%, continuing a five year decline. While allocations to private equity and equity real estate declined slightly across all U.S. institutions, public pensions allocated 5.6% of assets to equity real estate and endowments devoted 8.3% of assets to the alternative investment. Institutions allocated 2.6% of total assets to hedge funds in 2007, up from 2.2% in 2006.
The report suggests that many of these trends will continue and possibly intensify in 2008, as one-quarter of all U.S. funds interviewed in late 2007 said they expect to significantly reduce allocations to active U.S. common stocks within the next three years, while only 3% plan to increase these allocations.
Thirteen percent of institutions polled plan a major increase in allocations to active international equities, while 10% say they expect to make a significant increase to global equities. Almost one-third of institutions plan to significantly increase allocations to private equity, 23% expect to increase hedge fund allocations, and 21% plan to boost equity real estate allocations. In each case, only 1%-2% of institutions plan to cut their allocations.
“Our research reveals that diversification remains the dominant trend in institutional portfolios,” says Greenwich Associates consultant William Wechsler, “and in general, this diversification is taking two forms: The shift of assets into alternative investments and allocation adjustments that reduce the level of ‘home-bias’ and change portfolio composition to better reflect global market capitalization.”
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